The Pros and Cons of Different Price Scales

2scale2220913When you use trading charts to assist you in detecting quality trading opportunities for spread bets then you can either select an arithmetic or logarithmic price scale. You do not need to be intimated by this prospect because your software package will completely install your choice for you. However, in order to make the optimum selection, you will need to acquire an appreciation about the merits of these two price scales. This article is intended to help you accomplish this objective.

 

The Arithmetic Scale

For instance, the arithmetic scale is simple to understand and implement. This is because it presents increments of identical size. This feature implies that if price climbs between 50 and 100 then this is exactly the same distance as if it advanced higher from 120 to 170, since both movements are precisely 50 points in length.

 

The Logarithmic Scale

In contrast, the unit settings of the logarithmic scale varying in length. Although, this scale looks strange at first sight, it possesses features that can be extremely useful to you. In particular, you will note that as price advances up the y-axis of this scale then the spaces between units shrink dramatically in size. As such, price needs to record increasingly larger increases in movement as it approaches the top of the scale in order to advance by one unit.

This is because this scale is designed so that the distance between units represents the same ratio. For example, if price advanced from 20 to 40, then it would achieve the same distance on a logarithmic scale as when it moves from 100 to 200. This is because in both cases, the distance would have doubled.

 

Advantages of the Different Scales

Although this all sounds intriguing, do the different price scales possess any advantages? Essentially, the logarithmic scale comes into its own whenever you are studying an asset over a number of years or if it is experiencing high levels of volatility. As this scale can then help you to distinguish true price patterns from random noise, you will discover that it can be extremely useful under such circumstances.

For example, should you really be concerned so much when price moves from 87 to 88 as from 1 to 2. The first movement should not arouse much interest as it was most likely generated by noise. However, the second one may be significant as price has doubled in value. If you simply deployed an arithmetic scale, then both movements would appear to be of equal importance as they would be displayed by the same distance. In contrast, the logarithmic scale would place a far greater emphasize on the 1 to 2 movement.

Although most traders have found that distinguishing this difference is not significantly important over short time periods, they do acknowledge its value over the longer-term. Essentially, they have discovered that the logarithmic scale can present a much clearer picture of the historically price movements of assets used to construct spread bets over longer periods of time.

 

Examples of Chart Price Scaling

Normally, the price scale is displayed on the left vertical y-axis. As stated, there are basically two variants utilized by traders.

1. The arithmetic scale displays equal price movements as identical unit spacing. For example, price advances uniformly up the scale no matter how high it climbs. The distance between 10 and 20; 130 and 140 and 260 to 270 are visibly exactly the same. No emphasize is placed on any particular range as they are all evaluated equally.

This means that although price movements are acknowledged to be the same in absolute terms, they are not in percentages. For instance, a movement between 1 and 2 is a 100% increase whereas between 99 and 100 is just 1%. However, on an arithmetic scale, the unit size will be identical.

2. The logarithmic scale exhibits units representing price movements as ratios. This scale is also commonly referred to as the semi-log scale. For example, movements of 10 to 20; 40 to 80 and 160 to 320 will all appear to be equal in length because they all represent increases of 100%.

In comparison, where both the distances between 50 and 100 and between 100 and 200 would be equal on the logarithmic scale, the second movement would appear much larger than the first on the arithmetic scale. The following diagram illustrates the distinctive features of the two scales.

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Which Scale should you use?

1. You should opt for the arithmetic scale when the price of the underlying asset of your spread bet is range trading within a restricted horizontal channel. In contrast, the logarithmic scale produces superior results during time of high volatility when price is fluctuating more wildly.

2. If you are analyzing trading charts over the short-term, then you will discover that the arithmetic scale is your optimum choice. Alternatively, you will be able to obtain a much clearer picture of historic price movements over longer time periods by utilizing the logarithmic scale.

3. As the logarithmic scale presents price movements in terms of ratios, you are advised to evaluate assets in relative terms whenever using it. For example, you should display parameters, such as the Price/Earnings Ratio (P/E) etc.

 

 

 

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