The Best Shorts in the Dow

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The

Dow Jones Industrial Average

is testing 10,000 for the first time in three years. If it breaks, and I think it will, many of its components will offer

excellent short-sale opportunities . Of course, choosing wisely is desperately important when trading Dow stocks because the venerable index rarely generates losers without also creating new leadership.

Current index leaders include

Wal-Mart

(WMT) - Get Report

and

Proctor & Gamble

(PG) - Get Report

. Both are quasi-recession plays that could break down along with the rest of the equity universe, if the worst-case scenario unfolds. However, I think it makes more sense to stick with weak stocks for downside profits, instead of top-picking the most resilient ones.

It's also dangerous to sell-short too late, after a deep plunge has already wrung out major downside. This is a big problem right now because many Dow stocks are technically oversold after the most recent plunge. So, the best candidates need to strike a balance between weak technical patterns and favorable entry timing.

There's one more thing to consider when looking at Dow Industrial short sales. The testing period at 10,000 could take a long time, perhaps even into November because beaten down bulls will make a stand there. With that in mind, it's doubtful we'll see a clean breakdown without a series of whipsaws that leave everyone exhausted.

3M Company

(MMM) - Get Report

was a top Dow performer for over 20 years, before topping out in the low 90s in 2004. It then dropped into a broad sideways pattern, with support in the upper 60s. The stock rallied back to the old high in July 2007, nosed above resistance for two months, and sold off sharply.

It sold off to range support in July of this year, bounced weakly and then fell apart, breaking the 2006 low. This violation opens the door to a long-term downtrend that's headed for eight-year support at 50. A break of that level has dire consequences because it could trigger a secondary selloff into the low 30.

Intel

(INTC) - Get Report

sold off from 76 to 13 during the last bear market and rallied up to 34 at the end of 2003. It's been trading within the boundaries of that broad range for almost five years now. The 2001 swing high and deep selloff low became inception points for a symmetrical triangle that defined the long sideways pattern, at least until last month.

The stock carved out five swings within the huge triangle and came to rest at pattern support in mid-September. It broke that level decisively two weeks ago, triggering a multiyear sell signal. How low can this stock go, given it's already trading in the mid-teens? Sadly, one logical target methodology points to a selloff below five dollars.

Hewlett-Packard

(HPQ) - Get Report

has gone absolutely nowhere in the last two years, despite positive press and pundit table pounding. Notice how the stock has carved out a broad symmetrical triangle, with boundaries in the upper and lower 40s. Price rolled over and dropped into support last week and may be setting up for a large-scale breakdown.

However, there's no sell signal yet, and downside volume has stayed within logical boundaries. But the rollover pattern is now complete, just like the larger Intel triangle. Bottom line, this is a stalking setup, in which market players should wait on the sidelines and wait for a breakdown through the three lows at 40.

Caterpillar

(CAT) - Get Report

rallied from 16 into the lower 80s between 2003 and 2006. It then dropped into a broad triple-top pattern, with support just under 60. The stock broke down on higher-than-average volume last week and imploded over 15 points, before bouncing higher on Monday afternoon.

I wouldn't chase a short-sale down here. Instead, wait for the stock to recover and tick back up to new resistance in the upper 50s. This is big pattern, so that pullback might not unfold until later in the fourth quarter. But patience could be rewarded with a fresh sell signal that yields a downtrend into the low 30s.

Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

Farley is also the author of

The Daily Swing Trade

, a premium product that outlines his charts and analysis. Farley has also been featured in

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,

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,

Tech Week

,

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,

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,

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,

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and

Online Investor

. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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