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Dow Dogs Are Busy Playing Dead

These laggards aren't likely to firm up for some time, but a few could have healthy upside.

This column was originally published on RealMoney on Oct. 24 at 11:59 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.

The

Dow Jones Industrial Average

is trading at new highs this week, but not all components of the venerable index are enjoying the ride.

A hard-core group of underperformers has been applying downward pressure on the index for some time.

Let's identify these laggards and see if they'll help or hurt your portfolio in the coming months.

Leadership within the Dow rotates tremendously over time.

Huge chunks of index capital flows out of overstretched leaders on a regular basis and into underperforming components, in strategies designed to take advantage of reversion to the mean attributes.

So, theoretically at least, today's laggards could become tomorrow's big winners.

General Motors

(GM) - Get General Motors Company Report

is a perfect example of this rags-to-riches methodology.

In April, I noted that the stock was sitting at the bottom of the Dow loser list.

But just six months later, the automaker has jumped to the top of the performance pile, rewarding long-suffering investors with highly respectable gains.

Today's laggards could offer excellent opportunities for investors with strong appetites for risk.

However, the charts predict that most of these stocks will head lower in the short term.

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Take your time before exposing yourself to these issues and wait until underlying money flow signals the start of a turnaround.

Alcoa

(AA) - Get Alcoa Corporation Report

rallied to a two-year high earlier this year in a strong move driven by the parabolic rally in the industrial metals group.

The stock topped out at the same time as its peers and started a persistent decline that shows little bottoming action.

It hasn't printed any higher highs or higher lows since its May reversal.

Focus on the declining channel that's been in place since August. The first sign of recovery will come when the stock gathers enough strength to break out of this pattern. Note how channel resistance corresponds with the 50-day moving average at $28. That should be the key inflection point in upcoming weeks.

Home Depot

(HD) - Get Home Depot, Inc. Report

has been dead money for so long, it's hard to recall the last time the company inspired either technicians or investors. A look at the long-term chart suggests that's not going to change anytime in the near future. The problem starts with the broad sideways pattern between the low $30s and mid-$40s.

The stock dropped to the bottom of its trading range in July, bounced off support and stalled out this month at intermediate resistance near $38. Underlying accumulation suggests the next move will take it back into the $40s, where it again faces major resistance. That's where longer-term players should watch for a possible entry.

Caterpillar

(CAT) - Get Caterpillar Inc. Report

sits at the bottom of the Dow performance list after last Friday's high-volume plunge. The post-earnings breakdown dropped the stock toward its 2006 low at $57. The decline also triggered a breakdown through support between $63 and $65. This predicts the start of a downtrend that will last another one to three months, at minimum.

Intense distribution triggered by the selloff will take time to wash out of the system. Note the four-year trend line in the mid-$50s. It's likely the stock will reach this key support level before beginning a sustained recovery. Potential investors should stand aside for now and wait for a bounce at that level before entering new positions.

3M

(MMM) - Get 3M Company Report

looks interesting when we back up to the monthly view. A three-year decline dropped the stock into an eight-year trend line, where it bounced strongly two months ago. Also note how the long downtrend has evolved into a massive bull flag pattern. These elements suggest the stock will continue to recover in the coming months.

This is an enormous pattern in which exact timing is difficult to visualize. My best guess is that it could break out of the decline by year's end and test its all-time high at $90 in the first half of 2007. 3M might be the perfect choice for a Dow component laggard-to-leader trade.

I was surprised to see

Citigroup

(C) - Get Citigroup Inc. Report

make the laggard list, but it makes sense when looking at relative positioning of all index components. While the financial giant has recovered off its summer lows, the stock has gone absolutely nowhere in the last two years. And the five-point bounce since July is uninspiring, to say the least.

The stock could pull back in the fourth quarter but accumulation is improving, albeit slowly. This suggests the rally might continue early next year until it hits resistance from 2000 at $60. However, we're unlikely to see a rally above that level, so the stock might be of little interest to Dow investors in coming months.

At the time of publication, Farley held none of the stocks mentioned, although holdings can change at any time.

Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;

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