Using Stock Charts for Technical Trading: Linear versus Log Scales

It can sound quite fancy when someone says they’re using a ‘log scale‘ on a chart. Most people probably scratch their heads at the term. But in actual fact it’s a pretty simple concept.

Generally speaking there are two scales for charting – normal (linear) or log (logarithmic).

Let me explain the difference as this is an important concept for new technical traders to understand.

Imagine a stock that goes from $1.00 to $100.00 over a number of years. When the price initially goes up to $2.00 it’s a 100% gain in the stock price. But when the stock price goes from $99.00 to $100.00 it’s still a $1.00 price move, but in percentage terms is has only gone 1% higher.

So the same $1.00 move has caused a 100% gain in one instance and a 1% gain in another instance, depending on the stock’s starting price.

On a normal chart with each dollar separated by the same distance, you wouldn’t gain a sense of the percentage moves in the price over time. See the long term price chart of Fortescue Metals [ASX: FMG] as an example.

First using the normal (linear) scale for the price:

Fortescue Metals Group – Normal Scale

Technical trading
Click to enlarge

 

Now using a log scale for the price:

Fortescue Metals Group – Log Scale

Technical trading
Click to enlarge

 

Both of these stock charts are of the same thing. They show the huge rise in FMG since 2002 from a penny dreadful at 1c to its current price at $5.35.

The log scaled chart has a scale that shows the percentage changes in price over time rather than the dollar changes. In other words, the distance between $1.00 to $2.00 will be the same as the distance between $2.00 and $4.00.

When the stock price moves as far as FMG has then it can make more sense to look at it with the adjusted scale. Because let’s face it, these charts seem to tell a very different story. Without the benefit of the log scale chart it looks like FMG completely crashed in 2008, whereas the Log scale chart makes the fall seem far less dramatic compared to the immense percentage rise that FMG had experienced.

If you like using trend lines on charts, it can make more sense to use a log scale chart as it can provide a clearer and more obvious trend line, especially if the price has experienced parabolic price action on the normal chart.

Murray Dawes+
Slipstream Trader

 

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Murray Dawes is the Editor of Pivot Trader and contributing Editor at Money Morning. He was one of five, from 5,000 applicants, chosen for a graduate position with the Swiss Banking Corporation — now part of banking giant UBS. The bosses quickly cottoned on to his potential and pushed him up the ranks as a futures broker on the floors of the Sydney Futures Exchange. Murray later broke out on his own and developed custom trading systems to trade leveraged financial instruments like futures. Due to his success, Murray became the ‘hired gun’ trader for Australia’s rich and famous. Today, Murray runs a trading service through Port Phillip Publishing to help everyday Aussie investors use his advanced trading methods.

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