Dow Jones Transports ETF: A Chart View

By L.A. Little of tatoday.com, author of Trade Like the Little Guy.

The iShares Dow Jones Transportation ( IYT) exchange-traded fund is both tradeable (liquid) and highly correlated to the Dow Jones Transportation Average. It's the investment vehicle of choice to trade the transportation sector.

The weightings aren't exact when compared with the transportation average, but they do track quite closely. As can be seen, railroads account for a significant portion of the ETF weighting.

Since Warren Buffett announced a buyout of $100 a share for the remaining Burlington Northern ( BNI) stake, IYT has shot up almost 16%. This has led some to think that Buffett might be the latest bubble blower. I'm not so sure we can jump to such a conclusion though.

Before one can even begin to debate the question of whether Buffett is bubble blowing, we probably need to define just what a bubble is. I am unaware of a concise, written and agreed to definition, but the general thought seems to be laced with these two criteria:
  • Prices have moved up precipitously over some period of time.
  • Price points are extreme (far too high) when compared with the real value of the underlying asset (you can choose the various measure to use when determining real value depending on the asset class being evaluated).

There may be other criteria, but those two seem to always be tied to the bubble talk. Given this loose definition, are the rails the latest bubble? Here's a weekly chart of IYT.

In the upper right-hand corner, I've highlighted the price action since Buffett's buyout was announced. It seems to me that a rise of 16% is nowhere near the kind of price advance needed to be considered as a bubble. Now if the prices double from here, then that might be a different story. Seriously, IYT was trading at these price levels before the Buffett bid.

So rather than talk of bubbles, let's instead talk about how to make some money. On the intermediate-term time frame, we can see that the rise since the May highs has been a suspect advance. As we know, a suspect advance can continue but it eventually tends to come back to the area where suspicion was created. In the case of IYT, we should see prices retrace to the $61.31 price point on a weekly basis.

Now, to decide if that would be a good area to buy, we flip to the long-term time frame to assess the longer-term trends and see if they are suspect or confirmed. Here's a monthly chart.

What we find in this view of IYT is that the trend is confirmed as volume did expand as swing points were erased. So we have a congruent view between the two time frames. That's good, that's what you want if you are considering a purchase.

For the investor (long-term trade), the ideal buy point is a retest of the support zone area shown on the chart. You can compare the volume on both a weekly and a monthly basis when the test does occur to see that it is lighter. If it is, then that's your buy.

Now, if prices do not retrace and retest but instead break out to the top side, then the entry purchase is problematic. Looking at the monthly chart again, you can see that the next resistance level of significance is around $81. On a breakout, you might get in around $74, so you have a target of a $7 profit. Your stop-loss order would need to be around $69, so your risk-to-reward equation doesn't work. As a technical trader, to make money you need three things:
  • 1. A technical setup
  • 2. A reasonably good probability of success on the setup
  • 3. Risk-to-reward parameters that work

On a breakout, IYT is offering only two of the three. Unless you are trading short term and are willing to take on a greater risk of being stopped out (employing tighter stops), then there are probably better trades than the transports right now. If you want this trade, then root for a pullback, because that is the sweetest setup.

So until next time, keep trading the charts!

At the time of publication, Little had no positions in the securities mentioned.

L.A. Little is an author, professional trader and money manager who writes daily on tatoday.com, a free educational site for traders and investors. He has been featured in Stocks & Commodities magazine and is the author of Trade Like The Little Guy.

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