Tips on Technicals - Logarithmic Scaling
Indicator type: |
Display |
Used to: |
Show changes in prices in relation to price levels |
Markets: |
All cash and futures, not options |
Works Best: |
Long-term charts and instruments with very large price moves (40% or more) |
Formula: |
N/A |
Parameters: |
N/A |
Theory: |
Rather than simply plotting price on the vertical axis in a linear fashion, prices are plotted to indicate magnitude changes. This means that the vertical distance drawn for an item that doubles in price is the same whether it goes from 5 to 10 or from 100 to 200. A linear scale would plot the same vertical distance from 5 to 10 as it would for 100 to 105. |
Interpretation: |
Many long-term trends appear to accelerate over time yet the underlying prices do not become overextended. Prices trade away from trend lines and new, steeper trend lines are drawn. Once again, prices trade away from the line. The reason is that the market is moving at the same rate in percentage terms but the absolute price changes are rising. Log scaling keeps trend rates in perspective. |

The charts above show the stock price for Microsoft since mid-1986. Notice the price scales of the two charts are very different. Both start near 1 1/2 in 1986 and end near 54 in 1994. However, when prices rose from 2 to 4 in 1987, the linear scale (fig. 1) on the left shows a very small move. The log scale (fig. 2) on the right shows a very large move.
The vertical distance on the log scale for the move from 2 to 4 is the same as that of the move from 20 to 40. This simply means that prices doubled and provides for valid comparisons at any price level. It also allows for better trend line and pattern analysis. Note that the congestion zone taking place in 1988 and 1989 shows up much more clearly as a triangle pattern on the log scale. Note also that what appears to be a period of high volatility in 1992 and 1993 on the linear scale is put into better perspective on the log scale. Prices were no more volatile there than they were throughout the entire 9 year period shown.