Author: Mohab Ibrahim Abu Ahmad
Date of Publication: 06/10/2022
It is usual for mainstream media news channels to show a segment of breaking news on an asset like Bitcoin for instance. They exclusively use linear scale when they discuss the price chart of the cryptocurrency. Now, I think it’s more informative for them to use instead of linear. This is because it might be misleading when it comes to analyzing volatile charts visually. So, what’s the difference between the two? Why should you use logarithmic also, known as log scale chart, when reviewing a volatile asset price chart ?
What is a linear and a Log scale
Linear price scale—also referred to as arithmetic—represents price on the y-axis using equidistant spacing between the designated prices. Linear charts display absolute values. In Figure 1 we can see two price movements of Bitcoin highlighted with green horizontal lines that are of the same proportion (100% increase). And yet, the blue arrows may mislead us towards thinking that one was way more significant than the other.
Logarithmic price scale or log represents price spacing on the vertical o y-axis. This depends on the percentage of change in the underlying asset's price. A logarithmic price scale uses the percentage of change to plot data points so, the scale prices are not positioned equidistantly. As we see in Figure 2, proportional price movements of Bitcoin appear similar. This is because distances between the units represent a percentage change of the security rather than a unique unit of measure.
When to use Linear or Log
When a security has small price moves and choppy trading action, a linear chart is the best method for charting the stock. However, for volatile charts such as Bitcoin the logarithmic price chart makes more sense as it can visually capture the significance of the larger price moves. So, the more volatile the asset, the better a log scale is.
Moreover, for long term perspective and monitoring. Use log because on linear charts a move from 10 to 20 appears identical to a move from 100 to 110. This can be misleading because a 100% increase appears visually identical to a 10% increase. In such cases, large price movements are more accurately observed using log charts which focus on the percentage of the move. On the other hand, it’s more applicable to move within a tight range on a short time frame using the linear scale. In fact, this is because of the equal distribution in absolute dollar terms on the chart look Figure 4.
In addition, we analyze the price of a security using relative ratios such as P/E ratio, EP. Hence, when depicting the price of said security tracking, the movement in percentage is more appropriate. Still, it all depends on the type of security whilst more price explosive securities necessitate a log scale. Meanwhile, range confined ones where price is relatively stable are easier to trade on linear. Ultimately, most often traders are shown the ideal scale automatically by the platform they are using.
To sum up, it all depends on the type of security that you are reviewing and on the time horizon you are looking at. Nevertheless, next time you want to look at a volatile security with explosive price movements, make sure that you have your charts on a logarithmic setting especially for Bitcoin.