Scaling is important for drawing correct trendlines, support and resistance on charts. Which is why we need to understand it. Because otherwise we won’t know what we are doing. And that is why I will focus on it in this post.
Logarithmic and arithmetic charts
Arithmetic charts are plotted on a linear scale. This can be a chart looking at temperature for example. Equal distances represents equal amounts. The distance from a value, for example one or two, is the same as the distance from two to three on both the x and the y axis. So you are visualizing price in a linear manner.
Semi-log charts are quite different. They show the logarithmic scale on the y-axis. But the y-axis is percentages. These charts show similar percentage moves as being equally big. Which is helpful for spotting important moves on a chart going back longer in time.
The vertical distance on a 100% move appears as big whether that is a price move of 20 to 40 dollars on log charts. Or a move from 100 to 200 dollars. This is since they both represent the same percentage moves. Because of that they are often referred to as percentage charts. Below is the same chart of the Dow Jones Industrial average on a logarithmic scale.
Arithmetic scaling can be good for some things. For example when you are doing market geometry on your charts, or if you are daytrading. The downside of this scaling is that the big percentage moves, back in time, don’t appear as big on the chart, as the moves closer to the top. An example of this is in this linear chart of Berkshire Hathaway below. In this chart there was a sell off, between 1998 and 2000, which was a big percent change. But it almost does not show up on the chart in 2019. Because the linear chart only shows equal amounts.
Arithmetic charts display moves from 150 to 200 dollars as bigger than moves from 15 to 20 dollars. Even though they might be as important for traders when they happen. Because the percentage change is as big in both cases. And that is why log charts are more useful for swingtraders in my view.
Looking at Berkshire Hathaway on a logarithmic chart paints a whole new picture. The important move from 1998 to 2000 now looks a lot bigger .
For me personally, this is what I want to see. Because the big percentage moves are as important for me. And psychologically these anchor points can be at least as important as the big linear moves in number terms. Which means that they will be important for drawing trendlines, support and resistance.
Trendlines on log charts
Below is a picture of Facebook on a logarithmic chart. As you can see it is a beautiful channel showing several uptrends and pullbacks.
Now, look what happens when you use an aritmetic chart with the same trendlines.
Linear charts exaggerates the moves that are near the top of the chart. And they make the moves closer to the bottom look less important. This is not what we want on a longer term chart. Because the big percentage moves are as important psychologically and therefore for drawing trendlines.
Scaling for daytrading and swingtrading
I am not a day trader. Although I have tried this stressful endeavour for a period in my life. And it does not suit my personality. But I really admire the people that are able to trade this way. These guys have to process information very quickly and often does not have the time to think deeply about investments.
Daytraders need to be sharp, aggressive and mentally robust as no other group of traders. For them arithmetic charts makes sense to trade. Because they are trying to scalp or make money in the small moves of the market. And the logarithmic chart is not going to make an impact on these smaller moves. But for any other kind of long term, weekly or daily trader logarithmic charts are the best choice.
I am a swingtrader and technamentalist, trading for the long and intermediate term charts. And I prefer logarithmic charts. Because I feel that I get a better picture of the swings that way. In addition they are the best choice for drawing trendlines. But there is no right or wrong here. Some traders prefer logarithmic charts and others prefer linear charts. The important thing is to find what works best for you.