Tax selling pressure is likely to pick up into Dec. 31, with thousands of issues trading in the red for 2018. More importantly, many of those stocks peaked at much higher prices, attracting bagholders who need to decide if they want to take short-term capital losses. It isn't as bad for long-term shareholders with positions taken in prior years because major benchmarks are trading above 2016 and 2017 levels, suggesting that many of those positions are still profitable.
Two opposing strategies set up at this time of year for the fast-fingered crowd looking to book opportune profits. The first sells short stocks that are likely to face tax selling pressure into year end, while the second buys those stocks or similar candidates at the start of the new year, expecting the January effect to kick in. This price action doesn't always unfold as expected, but the likelihood is higher in 2018 than in the past two years due to the large supply of losers.
Finding the top plays for tax selling is easier than you might expect. Pull up a list of S&P 500 stocks you want to trade and sort by percentage distance below the 200-day exponential moving average (EMA). Identify the worst candidates on this list and review their overbought/oversold readings through stochastics or another relative strength oscillator. Candidates at overbought levels often produce the best results because the positioning suggests a healthy supply of losers that haven't sold yet.
Mohawk Industries, Inc. (MHK) has had a tough time in 2018, dropping more than 57% year to date. More importantly, the stock hit an all-time high at $283 in December 2017, meaning that many shareholders bought the top and are sitting on catastrophic losses, assuming they were "holding for the long term." We have to assume that these unhappy investors have an important decision to make in the next two weeks.
The stock gapped down on Oct. 25 and hit a five-year low at $113.45. Two attempts to fill the gap into December have failed, and Mohawk shares are now trading less than five points above the October low. A sell-off that pierces the Dec. 6 reversal at $116.67 could issue a useful sell signal, ahead of new multi-year lows into year end. At this point, a stop loss is need above the weekly high at $123.
IPG Photonics Corporation (IPGP) has lost nearly 44% year to date. It hit an all-time high at $264.08 on Jan. 24 and turned tail, breaking a nine-month topping pattern in a huge July gap that hasn't been filled yet. The stock gapped down again in October and bottomed out a few weeks later, after gapping down 23 points and reversing in a buying spree that ended the session on the plus side.
However, the recovery wave ended just three days later about halfway into the October gap. It tested that level earlier this month and reversed, yielding a steady decline that has reached within 12 points of the October low. That level may not break between now and Dec. 31, but a continued downtick into that price could generate healthy short sale profits. Traders should keep stops tight in this price structure because a single multi-day bounce could sharply reduce profit potential.
DXC Technology Company (DXC) has fallen nearly 30% year to date. More importantly, the stock posted an all-time high at $96.75 less than three months ago, raising the odds for a healthy population of bagholders looking to exit positions into year end. Selling pressure intensified after the stock broke 2018 range support at $76 in October, stair-stepping lower before bouncing at $57.59 about three weeks ago.
The uptick stalled in the mid-$60s just one week later, giving way to a gravity-laden downtick that is now testing November support. A breakdown will be significant because it will also break psychological support at the low posted after the April 2017 initial public offering while dropping the stock to an all-time low. In turn, original shareholders still positioned will be stuck in losing positions.
The Bottom Line
Stocks that have high percentage year-to-date losses and/or those that are trading well below 2018 highs could offer profitable short sales during year-end tax selling season.
Disclosure: The author held no positions in the aforementioned securities at the time of publication.