Ask Colin

Could you please explain why log scales are used on the vertical axis of price charts.

There are two basic scale types used for bar and line charts.

The most common is the semi-log scale, which has a linear time scale and a logarithmic price scale.

The less common is the linear chart, which has a linear time and price scale.

The reason why the semi-log chart is the most common and the preferred scaling is that it does not distort the relativities when there is a large dynamic range in price. If there is a large dynamic price range, then the portion of the chart at the lower areas of the price scale will be reduced to insignificance and the portion of the chart at the upper areas of the price scale exaggerated out of all proportion.

While this ability to be able to see the price action is significant, it is even more important in keeping a sense of proportion to price movement. The aim of trading and investment is to maximise our percentage return on capital employed, not merely the dollar gain in price of a stock. The liner scale shows a gain of 1c at a price of $1 to be equally important as a gain of 1c at a price of 10c. The first is a 1% gain, the second a 10% gain.

A further reason is that we should never draw a trend line on a linear chart unless there is a quite small dynamic range. A trend line measures the speed of price change. To draw it on a linear scale will be quite misleading.

Many people use linear charts for two reasons: Firstly, ignorance of the mathematics of investing. Secondly, and legitimately, for studies of short term price action in the absence of a large dynamic range in price over the period.

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