Caesars Entertainment Soars - A Case Study In Technical Analysis

| About: Caesars Entertainment (CZR)

Back on February 11th I wrote a piece on Caesers Entertainment (NASDAQ:CZR) explaining some of the reasons why it was, and still is, difficult to analyze the company from a purely fundamental standpoint: "Why Fundamental Analysis Failed in Caesars Entertainment's Case." The stock closed trading that Monday at $12.59 after having reached as high as $14.25 the Friday prior, capping off a monster 64% two-day rise on the news that Chris Christie would support a 10-year online-gambling trial in New Jersey. Since then the stock is up 39% and has more than tripled off of its lows in November 2012. Other gaming stocks such as Boyd Gaming (NYSE:BYD) and Penn National Gaming (NASDAQ:PENN) saw very mild price increases in comparison, neither of which were sustained.

It is interesting to note during this whole rise that the majority of articles on Caesars were bearish. For example, see the following articles: "Caesars Entertainment's Future In Doubt: Parabolic Rise Provides An Excellent Opportunity To Exit", "Caesars' Short Case Clearer, Simpler -- And Stronger", and "An Investment In Caesars Is A Roll Of The Dice." These pieces relied primarily on fundamental analysis to derive their conclusion, and based on the data they were working with the outlook was perhaps clearly bearish. However, one of the problems with using fundamental data is that it is often outdated, is often already priced into the market, and is often not clearly understood. In addition, there is a lag in the media that often highlights bearish or bullish outlooks at the extremes of price movements, after the majority of the move has happened. For instance, we are finally starting to see some bullish coverage on Caesars after a 388% price rise, with one story even claiming Caesars as one of the "4 Best Stocks in the Market." Perhaps it took some time to fully digest the impact of Christie's actions coupled with the improving US economic outlook, and the case remains that information is not always efficient. Samuelson's Dictum states that there are indeed micro inefficiencies in the market.

What's the Point?

I am not here to bash fundamental analysis, but I would like to point out that using Technical Analysis on certain stocks works well where the fundamentals are hard to comprehend and model; this in turn can provide valuable information and more importantly actionable investment criteria. Caesars is a perfect example of a stock that is suitable to examine with the use of Technical Analysis. As with all of my articles, my goal is to educate, and I will examine my thinking behind the initial idea and setup, as well as the bullish technical signals Caesars exhibited on the way up.

Supply and Demand

Some of the reasons I liked Caesars as a long (and why I thought it was a terrible short) was the lack of a large public float coupled with a high debt-load and short interest, giving it a high Beta and the potential for a short squeeze with a crowded short position in early 2013. Additionally, by the end of 2012, the stock exhibited a persistent downtrend for pretty much the entire time the company had been public. Going even further back, you may remember the first scheduled IPO was scrapped, indicating Caesars Entertainment had become an excellent potential multi-year contrarian turnaround story, but only IF and WHEN the stock decided to turn around.

As I mentioned, the company has a massive debt load and relatively few shares traded publicly, with most being held by Apollo Management subsidiary Hamlet Holdings. This creates the possibility for extreme persistent one-sidedness price action; this is Economics 101. Technical Analysis is based on principles of economic theory rooted in supply and demand. Where there is strong demand and relatively little in the way of supply - price rises, in this case, rapidly. However, be advised this is a double-edged sword. I liked the potential for a serious reversal move for these reasons.

The Turnaround

As I mentioned, Caesars was an excellent turnaround candidate, but not until it showed signs that it would be likely to do so and maintain its advance. For this reason I stalked Caesars for the better part of half of a year, all the while waiting and watching. During this time, CZR kept inching lower and lower, reaching an ultimate low of $4.52, and then started ticking up. When CZR broke its weekly downtrend line, I began to take notice that a sustained reversal was potentially imminent. The exact chart I looked at is posted below.

CZR Weekly Chart image taken on 1-27-13
(Click to enlarge)

You will also notice Fibonacci or Golden Ratio price targets. Briefly, these are targets where the price of the stock should react to and find support (in an uptrend) based on the length of the previous move. Determining where to start and draw measured moves is enhanced by experience, but essentially I use the Ray Barros method of Initial Price Movement (IPM). In this case Caesars reacted almost exactly to 50% and held above the 61.8% level. Now I really started to get interested in February.

While the weekly trendline had been broken, the daily trendline remained intact, and in fact, the stock briefly kissed it at $8 before turning lower again. Maintaining a watchful eye on the long-term daily trendline and the shorter-term symmetrical triangle, an investor would have been able to confidently buy on the breakout of the symmetrical triangle or downsloping trendline given all the knowledge gathered watching the stock. You can view these charts below.

CZR Daily Chart Trendline Breakout
(Click to enlarge)

While some might say that you could have drawn several downward sloping trendlines, the truth is that there is a right way and wrong way to draw the lines, and Technical Analysis is a study like anything else. To draw a downward sloping trendline, typically, you will start from the highest peak and draw down to the next highest peak. There are additional criteria, however, such as drawing from upwards closing to upwards closing candle points or downwards closing to downwards closing points; price should also test the line at a much lower price point (in this case it did at $8 before breaking out). The stock should breakout away from the line quickly or move sideways with little activity before advancing. A single test of the line occurs occasionally as it did here with Caesars. Failure to maintain a sideways or positive momentum is often the signal of a false breakout and renewed downtrend.

CZR Daily Symmetrical Triangle Breakout
(Click to enlarge)

The breakout on volume at the green circle was a bullish clue, as was the simultaneous breakout of the daily downtrend line and buy signal in the PPO (a percentage-based MACD, up top on the chart).

The Takeaway

Setups as sweet as these are hard to come by, but when you spot them, you will often quickly know whether or not they are going to work or not. Technical Analysis is all about probabilities, and makes no claim to be able to predict actual results. It may appear as though using Technical Analysis requires little work and is a potential way to get rich quick. This couldn't be further from the truth. While technical traders and investors have seen stellar gains on Caesars, remember those traders were not getting "paid" all the while they were waiting for the right setup. Being diligent and persistent in your analysis will allow you to be patient and strike only when the situation is favorable. Do not forget to be equally diligent to spot warning signs of a possible trend reversal in order to take profits at favorable levels. Though CZR still has excellent upside potential, the risk-reward ratio has diminished significantly, and trimming existing positions is advised following a tight trailing stop-loss in order to capture any additional and sudden price rise.

Disclosure: I am long CZR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I have no plans to transact further buys or sells in CZR for at least 48 hours. Information is provided for educational purposes only.