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Dow Jones Industrial Average
has been on a tear this spring, rising more than a thousand points since the beginning of April. As the financial media have pointed out repeatedly in recent weeks, Dow components and other big-caps are outperforming the broad market by a wide margin.
Not surprisingly, the impressive rally has made it harder to find good opportunities among the 30 residents making up the average. High percentage moves on these stocks, without noticeable pullbacks, have skewed the reward/risk ratio sharply against new positions. So extreme caution is advised for anyone trying to board this moving train.
Which Dow stocks are most susceptible to a selloff right now? Well, the list is growing longer by the day. I'd avoid:
- Honeywell (HON) - Get Honeywell International Inc. (HON) Report;
- Coca-Cola (KO) - Get Coca-Cola Company Report;
- Verizon (VZ) - Get Verizon Communications Inc. Report; and
- 3M (MMM) - Get 3M Company Report.
All of these stocks have posted outsized gains and are now sitting at or near resistance levels.
I'd even avoid
, despite all the excitement surrounding its merger with
. The post-news rally has lifted price right into $40, where the stock reversed sharply to the downside after uptrends in 2001 and 2004. This week's sharp uptick might signal an exhaustion event rather than the start of a new uptrend.
But there are still good ways to play the Dow rally, if you're patient and pick your fights carefully.
The components have a noticeable tendency to play musical chairs, with capital shifting out of one strong performer and into another, as the index marches higher.
The trick is finding these beneficiaries while they still offer relatively safe entries.
In this regard, here are four Dow stocks that still show upside potential, despite the historic run of this historic index:
Merck dropped sharply in late 2004, when its arthritis drug, Vioxx, was pulled off the market. It took more than two years for the stock to bottom out and regain the lost territory. The round trip was finally completed last month when price gapped above the swing high printed before the selloff. Notice how well it's held up since this vertical push over $50.
The stock is in a good position to follow through on its April surge and head toward $60. It faces further resistance at that level, marked by the June 2003 high. But the rally would still offer excellent profits for timing-conscious traders and investors. An entry signal will trigger if and when the stock presses above the recent high at $52.63.
IBM slid through $100 during a 2002 selloff and failed to remount that critical level for more than four years. The stock finally burst above resistance after first-quarter earnings, with price running up to $103 and then breaking higher on Wednesday.
With round number $100 now providing support, the pattern shows an excellent reward-to-risk profile. Coincidentally, a push above $105 will also trigger a breakout through a seven-year trend line. That rally burst might be substantial, with at least 15 points of upside coming in the next few months.
Hewlett-Packard raised second- and third-quarter guidance on Tuesday, spiking the stock to a seven-year high. Although the uptrend looks overextended after its 10-week run, I doubt a major pullback will begin anytime soon. But let's play it safe for now and see how price handles new support at $43.50.
Look for that level to get tested in the next one to two weeks. If support holds, this week's news should set into motion a renewed uptrend that carries well into summer. The obvious target for the uptick lies at $50, where price faces another layer of resistance. But there's also a chance this market leader is getting ready to test its all-time high in the $60s.
American Express broke above six-year resistance at $55 in September and rallied to an all-time high. The stock reached $62.50 a few weeks later and then pulled back to test new support. Price bounced right on schedule and resumed its uptrend, pressing above the rally high last week.
This confirms the long-term breakout and signals a period of increased momentum. The next upside target lies at $71, which marks out a measured move equal in length to the recovery off the March low. Longer term, look for the stock to continue its powerful uptrend and remain a top Dow performer for the rest of 2007.
At the time of publication, Farley was long IBM, 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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