Charting the Fallen

Most folks are not contrarian by nature. We generally like to be on the prevailing side, whether it be in the stock market or the NBA.

Ever wonder why the sports paraphernalia of the latest championship team enjoys a dramatic increase in buying interest before the confetti stops flying? It's because of the common desire of sports enthusiasts to be associated with a winner.

Although the financial market injects money into the equation, crowd behavior is still predictable.

We don't hear much about Google, Hansen Natural, Apple, Chicago Mercantile Exchange or Titanium Metals these days because their best days appear to be behind them. They are no longer seen as the champs they were a few months ago.

Therein lies the problem. The crowd is searching in vain for a champion to follow.

Where are the leaders that can attract the crowd's money? I can't find 'em. Can you?

I believe this tendency of the crowd to look for new leadership is one of the reasons market tops are more process-driven. They take some time to play out as the crowd slowly realizes that what has worked before is no longer working.

Only when the crowd finds a new leader on which to pin its hopes do folks start feeling confident enough to buy. And only when no leaders emerge does the broader market transition from uptrend to downtrend.

So far, I don't see any potential leaders -- but I continue to look.

Let's look at a weekly chart of the S&P 500 to get a clear view of where we are in the price cycle.

The multiyear chart of the S&P below shows an intact uptrend -- although it certainly doesn't feel that way.

I've highlighted the last several troughs, each of which was higher than the last, and each of which was followed by a higher high. If this pattern continues (and there is every reason to believe it will ... until it doesn't), then the S&P is beginning to look compelling.

We are still, however, in search of that championship team to follow. Got any ideas? I don't.

Today, let's look at the charts of stocks that have seen better days, including Chesapeake Energy (CHK - commentary - Cramer's Take), Bank of America (BAC - commentary - Cramer's Take), TIM Participacoes SA (TSU - commentary - Cramer's Take) and Walter Industries (WLT - commentary - Cramer's Take).

But first, let's look at one of our fallen leaders, the Oil Services Index (OSX).

The oil services sector was the "go to" sector in 2004 and 2005. But this latest breakdown beneath the March low does not bode well for the bulls. The new low in RSI is confirming the downtrend. Remember that daily charts are typically used for gauging entries and exits. From this vantage point, it's too early to buy, and a bit late to sell. There's nothing wrong with simply standing aside.

This weekly chart of Chesapeake Energy shows a break of support. Notice that the $27.50 level was tested a few times last November, once in February, and again just last week. Each time, demand was strong enough to bid the price higher. It looks as if that demand has been satisfied, and sellers will have to accept lower prices for their stock. The well-known technical analysis concept of "prior resistance becomes future support" provides a downside target of $22.50 -- the approximate level of the breakout last July.

Bank of America's May low was taken out in Tuesday's high-volume decline. This effectively confirms a trend reversal by establishing a lower low after a lower high. However, before getting too excited about this potential short, consider all of the churning that has occurred in the $45-$46 level, as indicated by the long price-by-volume bars. Such a large amount of trading creates a heightened degree of financial/emotional commitment at that level. So I'd avoid shorting BAC and instead look for support at lower levels.

A while back I featured TIM Participacoes as a short in the Short Advisor newsletter. Looking at this chart, I'd say that the recent consolidation effectively ends the first leg lower. However, any further decline is likely to create a void in buying interest because of the relatively light trading that has occurred at the $17.50-$22.50 level. If you're currently short, consider setting a tight stop until confirmation that current support is failing.

A reader requested my take on Walter Industries. As I look at this weekly chart, I see a stock that's way too late to be sold, but is not even close to flashing a buy signal. I've highlighted the prolonged area of consolidation that occurred during much of 2005. The stock cycled back and forth between $40 and $45, creating significant financial commitment at those levels.

However, you'll notice that the heaviest volume occurred during two weeks at the end of June. That was almost a year ago, so I would place less reliance on that trading activity to generate any type of buying interest now -- especially after the stock ran up to $70 over the ensuing five months. Remember that the impact of previous trading activity on current prices declines in direct proportion to time.

In other words, the crowd's financial investment in a particular price level becomes increasingly diluted by more recent trading activity. So, if you like WLT, you'd be well-advised to wait for a test of the $40 level before buying. After all, the price ran from $10 up to $70 in about two years. That amounts to a lot of potential profit-taking.

Be careful out there.

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At the time of publication, Fitzpatrick had no positions in stocks mentioned, though positions may change at any time.

Fitzpatrick is a freelance writer and trading consultant who trades for his own account in Encinitas, Calif. He is a former co-manager of a hedge fund and teaches seminars on technical analysis, options trading and asset-protection strategies for traders and business owners. Fitzpatrick graduated from the McGeorge School of Law and was a fellow at the Pacific Legal Foundation, a nonprofit public interest firm specializing in constitutional law. He also practiced law in the private sector before pursuing trading as a full-time career. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Fitzpatrick cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.