Chart Review: Chesapeake Energy’s “Abandoned Baby” As Shorts Descend Upon the Stock

Chesapeake Energy (CHK) has been in the news a lot partially thanks to the leveraged stock trading of its wheeling and dealing CEO. The stock has steadily dropped for over a year from a post-recession high of $36. When the company reported earnings two weeks ago, the stock responded with a strong gap up and a 6.2% gain on high volume. The very next day sellers returned in full force with single-day trading volume that was last seen in late 2008. CHK quickly lost all its post-earnings gains and went on to lose 14.6%. This gap up and then gap down formed what is known in candlestick charting as an “abandoned baby.” You can see from the chart how the post-earnings reaction was essentially abandoned, left behind, and thus trapping all buyers who found relief in that report (likely a lot of short covering).

Chesapeake Energy forms a rare abandoned baby pattern. THe bearish signal is confirmed with strong follow-through selling.
Chesapeake Energy forms a rare abandoned baby pattern. THe bearish signal is confirmed with strong follow-through selling.


Late in Friday’s trading session, CHK issued a press release along with its 10Q filing. The company secured a major loan from Goldman Sachs Bank USA (GS) and affiliates of Jefferies Group, Inc (JEF). However, the 10Q discloses the following way down on page 57 (emphasis mine):

“As part of our asset monetization planning and capital expenditure budgeting process, we closely monitor the resulting effects on the amounts and timing of our sources and uses of funds, particularly as they affect our ability to maintain compliance with the financial covenants of our corporate revolving bank credit facility. While asset monetizations enhance our liquidity, sales of producing natural gas and oil properties adversely affect the amount of cash flow we generate and reduce the amount and value of collateral available to secure our obligations, both of which are exacerbated by low natural gas prices. Thus the assets we select and schedule for monetization, our budgeted capital expenditures and our commodity price forecasts are carefully considered as we project our future ability to comply with the requirements of our corporate credit facility. As a result, we may delay one or more of our currently planned asset monetizations, or select other assets for monetization, in order to maintain our compliance. Continued compliance, however, is subject to all the risks that may impact our business strategy.”

In other words, two conduits for cash, asset sales and natural gas sales are in direct conflict with each other, a situation greatly exacerbated by low natural gas prices. The stock market reacted swiftly and CHK ended the day down 14%, close to its March, 2009 lows. This selling is the follow-through that confirms the bearish signal from the abandoned baby pattern.

I have been pounding the table to start buying natural gas plays in anticipation of a bottoming in natural gas prices. Clearly, Cheseapeke is NOT one of those plays. A lot of shorts agree as more and more descend upon the stock. As of April 30, shares short soared 29% in two weeks to 67.2M, representing 12% of the float. This amount is almost double what it was in January.

Be careful out there!

Full disclosure: long CHK puts

The calm that immediately followed was deceptive.

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