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How to Choose Between Linear and Logarithmic Scales for Charting in Finance



Linear (Arithmetic) and Logarithmic (Exponential Growth) Scales/Charting Explained

When you look at a chart of a financial asset, such as a stock, a cryptocurrency, or a commodity, you may notice that there are different ways to display the price movements. One of the most important choices you have to make is whether to use a linear or a logarithmic scale for the y-axis, which represents the price level. In this post, we will explain the difference between these two types of scales and how they can affect your analysis and trading decisions.

What is a linear scale?

A linear scale, also known as an arithmetic scale, is a type of scale that plots the price level changes with each unit change according to a constant unit value. This means that each change in price is represented by the same vertical distance on the scale, regardless of the price level when the change occurred. For example, if the price of an asset moves from $10 to $20, the vertical distance on the scale will be the same as if the price moves from $100 to $110, even though the percentage change is different (100% vs. 10%).

A linear scale is useful when you want to analyze an asset that is moving in a tight range or within a short time frame, such as intraday trading sessions. A linear scale can help you visualize how far the price must move to reach a buy or sell target, or to measure the size of a price swing. A linear scale can also show you the absolute value of a price change, which can be relevant for some trading strategies or risk management techniques.

What is a logarithmic scale?

A logarithmic scale, also known as a log scale, is a type of scale that plots the price level changes based on the percentage of change in the underlying asset’s price. This means that the distance between the prices on the scale decreases as the price of the asset increases. After all, a $1 increase in price becomes less influential as the price moves higher, since it corresponds to a smaller percentage change. For example, if the price of an asset moves from $10 to $20, the vertical distance on the scale will be much larger than if the price moves from $100 to $110, even though the absolute change is the same ($10).

A logarithmic scale is useful when you want to analyze an asset that is moving in a wide range or over a long time frame, such as multi-year trends. A logarithmic scale can help you identify the relative strength of a price movement, or to compare the performance of different assets with different price levels. A logarithmic scale can also show you the exponential growth or decline of an asset, which can be relevant for some trading styles or market conditions.

How to choose between linear and logarithmic scales?

There is no definitive answer to which type of scale is better for charting, as it depends on your personal preference, trading objectives, and market situation. However, here are some general guidelines to help you decide:

  • Use a linear scale when you are interested in the absolute value of a price change, or when you are trading in a narrow range or a short time frame.
  • Use a logarithmic scale when you are interested in the percentage of a price change, or when you are trading in a wide range or a long time frame.
  • Switch between linear and logarithmic scales to get different perspectives on the same asset, or to compare different assets with different price levels.

Conclusion

Linear and logarithmic scales are two different ways to display the price movements of a financial asset on a chart. They have different advantages and disadvantages, depending on your trading goals and market conditions. By understanding the difference between them and how to use them, you can improve your technical analysis and trading decisions.

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