Breaking Up in Flight

This column was originally published on RealMoney on June 29 at 2:01 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Aerospace and defense giant Boeing's (BA Quote) decline Tuesday caught my eye because the stock had been moving sharply higher in recent days.

It got me wondering about other key players in this broad sector, so I pulled up their charts.

Boeing hit an all-time high just below $90 in May and started to pull back in a bull flag pattern.

It found support in the mid-$70s a month later. It then gapped off the low in a vertical rally that lifted it 10 points in four days.

That move stalled above $86, and the stock rolled over in an orderly pullback that gathered momentum earlier this week.

Consider the stock's position before and after that lightning rally. It never had a chance to stabilize at lower levels before taking off to the upside.

This sudden shift in trend can generate an unstable pattern that triggers several weeks of volatile swings before a new trend develops.

It's possible this pullback might fill the June 14 breakout gap between $77 and $79. Such a plunge would be uncomfortable for shareholders and traders who picked up positions on the last rally.

However, this back-and-fill action could build a stable basing pattern for a follow-through rally to the stock's 2006 high. (See Boeing chart below.)

The aerospace and defense sectors have led the market in June. However, the leadership isn't too noteworthy, because few components have traded to 52-week highs in the current uptick.

This raises the possibility that the rally has been little more than a countertrend burst within a larger-scale decline. Let's see if other group members support this theory.

Lockheed-Martin (LMT Quote) rallied above its 2002 high in February and reached $77 before starting to pull back. It returned to this level a month later and sold off once again. The breakdown below $72 completed a double-top reversal. It is now sitting right at the level of its February breakout and below intermediate support at the 50-day moving average.

It's do-or-die time for this stock because a selloff below current levels will negate the breakout. This violation would set up a further decline that might reach into the mid-$60s quickly. Its inability to tick higher while other sector members have rallied increases the odds of a downside break in the next few weeks.

However, it's best to avoid new short sales until the stock cracks the 200-day moving average; as I write, it's about a point above that. A decline through that line in the sand should accelerate downside momentum and generate rapid profits on new short positions.

General Dynamics (GD Quote) gapped up to an all-time high in mid-April, but the rally stalled out immediately. The stock spent the next three weeks building a small double-top pattern that broke on May 12. It then surged through the 50-day moving average and into the low $60s, where it started to recover earlier this month.

I like the price action off the June low. Upside volume has been solid, and the stock has finally printed a series of higher highs. The cuplike basing pattern should hold the current pullback and keep price above $63 or so. That would set the stage for a follow-through rally that could test the 2006 high later this summer.

Since I suggested shorting Northrop Grumman (NOC Quote) in May, the stock has dropped over 6 points. Should profits on sales be taken here or will there be further downside in the weeks ahead? I think the current price action at the 200-day moving average offers the answer.

This is a long-term support zone where stocks often begin new uptrends, so the odds favor higher prices, until proven otherwise. Short-sellers should cover positions or place stop losses above the two-week high at $63.30. Alternatively a new sell signal will trigger if there's a wide-range breakdown from the two-week sideways pattern.

Raytheon's (RTN Quote) spring rally never approached its high of $76. The stock sold off after hitting $47 in May and started a decline that reached the 200-day moving average earlier this month. It then bounced up to the 50-day moving average, where it's been moving sideways for the last two weeks.

This isn't a bullish price pattern at all. Note how accumulation has been declining during the bounce off the lows. This reveals selling pressure just under the surface. Also, consider that upward progress stalled at the same time that group leader Boeing was making its run to multiweek highs.

The two bearish divergences suggest that the stock will roll over soon and drop back to its 200-day moving average. A breakdown at that long-term support level would offer an attractive short-sale opportunity for a downtrend that could persist for months and ultimately reach into the mid-$30s.

The defense and aerospace sector is a mixed bag right now, with several components pointing higher while others look ready to break down. It looks like a stockpicker's field where it's best to follow signals on the individual charts.

If I had to choose just one stock in the sector, it would be Boeing. Strong buying interest suggests the blue chip will see substantially higher prices in the months ahead.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
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