Why Arithmetic Stock Charts Are Worthless
Apologies ahead of time for titling the post so stridently, but I wanted it to capture people's attention. I have seen a lot of different charts on a lot of different blogs and some use Arithmetic (or Linear) Scale Price Axis charts to a) make counts and (more dangerously) b) draw trendlines on them. I disagree agree with this pretty vehemently and I wanted to share why.
You may have thought about this before, or you may have not. But I will invite you to do so in this post. "But a chart is a chart, right? An axis is an axis right? As long as it has all the data, you're good.... right?". This is not the case.
I am an engineer. I primarily perform thermal and structural analysis in the Aerospace industry. And it is critical to my job when analyzing and trying to comprehend data that it be viewed in the proper context. For example when looking at vibration test data, I look at Frequency Response vs. Frequency or Power Spectral Density vs. Frequency on a Log-Log plot. Same with Fatigue data (S-N curves). An Electrical Engineer looking at the band pass characteristics of a circuit would look at the signal response on a log-log plot.
Looking at any of this information on the wrong scales will improperly exaggerate signals at the top end of the axis and *hide valuable information* at the lower end of the function axis.
So first some terminology:
1) Log-Log Scale: Both your horizontal and vertical axis are logarithmic
2) Log-Linear (or Semilog) Scale: One axis is logarithmic and the other is linear / arithmetic. For the purpose of this discussion regarding stocks, the vertical axis (price) is logarithmic and the horizontal axis is linear
3) Linear-Linear: Both axes are linear. This is they way most people generally think about graphs (temperature vs. time, for example)
We will focus on Scales 2) and 3) for this discussion (obviously, log-log stock charts are not very meaningful, since the date is a linear set)
.... continued in comments section ...