Arithmetic and Logarithmic Price Scales
When you plot your charts, you will have a choice of using arithmetic or logarithmic price scales. Don’t worry, as the computer does the work for you, you don’t have to remember your school lessons about logarithms, you simply need to know the effect of each. The arithmetic scale, which was used on the previous chart, is the simple scale that you might expect. For each distance you go up on the left of the chart, the price increases by a set amount. In other words the distance from 580 to 620, which represents 40 pence, is the same as the distance from 660 to 700, also 40 pence.
You can contrast this to the logarithmic scale, which at first sight looks irregular. The spaces get tighter and tighter as you go up in price, which means you need a much bigger increase in price near the top of the chart to move the plotted points as much. Logarithmic scales are drawn so that the same ratios between the prices are represented by the same distance – for instance, the distance from 10 to 20 is the same as the distance from 80 to 160, as in each case the first number has doubled. Similarly, the distance from 1 to 10 would be as much as the distance from 10 to 100, and 100 to 1000 if the chart went that high.
For the previous graphs, it doesn’t make a lot of difference, so you might be wondering what the point of it is. But if you have a wide range of price, for example if you are looking at the chart for a number of years for a financial security, or if the security is very volatile, it can give you a better idea of the price movement.
Think about it this way. Are you really as interested when a price moves from, say, 99 to 100 as when a price moves from 1 to 2? Probably not, as in the first case it may be simply volatility but in the second case the price is doubling. Unless you’re using the logarithmic scale these would each be represented by the same distance. While the difference can be moot in many short term trading situations, in some cases such as when you’re looking at the security for long-term trends to get an overall picture of the industry, the logarithmic scale can be useful. When you are looking at longer time scales, where the prices rise significantly over time, you can find that a logarithmic price scale gives you a different perspective on the stock chart. We’ll look at an example when considering long-term charts. There are pros and cons to using each of them.
Constructing Charts and Chart Timeframes Implications
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