A Log In Your Eye
Even stocks crushed to a fraction of
their all-time highs can come back from the dead. But you can miss signs of life
if you rely solely on linear charts. To sharpen your diagnostic vision, eyeball
stocks using logarithmic charts.
A great example is MicroStrategy
(
MSTR |
Quote |
Chart |
News |
PowerRating).
On Friday, the stock jumped 18 1/8 to 62 1/4 on widespread rumors the
customer-management software company is close to securing $100 million through a private
placement.
That marks a fourfold advance from the
stock’s May 16 low of 16 9/16. Yet this explosive advance barely registers on a linear or arithmetic chart. To the eye, MicroStrategy’s recent price progress
appears minute in comparison to the preceding crash in the stock.
Now let’s check out a MicroStrategy
chart drawn over the same time frame but on a logarithmic scale. As you can see,
the advance off the bottom stands out bright as day.
So which chart is more accurate?
Neither. Each faithfully depicts price according to its scale. The problem lies
in how we interpret charts.
A linear scale portrays simple
arithmetic price moves. For instance, the vertical distance from $10 a share to
$20 equals the vertical distance between $100 and $110. That makes perfect sense
in an absolute sense. Each visual span on the chart covers an equal arithmetic price change of $10.
But in relative terms, the two price
moves are very different. A price increase from $10 to $20 represents a gain of
100% while a price increase from $100 to $110 spells a 10% return. Which stock
would you rather own?
On the downside, a price decline from
$20 to $10 translates into a 50% loss. A price decline from $110 to $100 comes
to a 9% loss.
Log charts depict percentage or
relative price moves rather than arithmetic price moves. The same vertical
distance measured anywhere on a log chart spans the same percentage gain or loss.
Linear charts work fine over short
time frames. But a visual distortion creeps in as you plot big price moves over longer time frames.
In a linear chart, a long-advancing
stock will appear to make greater and greater gains, causing the price to curve
increasingly upward, like a jet aircraft pulling its nose ever higher into the
sky. This can occur even if the stock’s percentage rate of increase remains
unchanged.
The opposite occurs when you depict a
long-declining stock on a linear chart. The price declines become smaller and
smaller, visually speaking.
You can see this on the linear-scale
MicroStrategy chart. Shares entered a decline after peaking at 333 a share on
March 100. The stock gapped below its 50-day moving average on March 20, losing
more than half its value, after the company restated its financial results.
The changes reduced MicroStrategy’s
1999 reported revenue from $205.3 million to between $150.0 million and $155.0
million. The bottom line changed from previously reported earnings of 15 cents a
share to a loss ranging between 43 to 51 cents.
From there, stock tried to rally,
stalled below its 50-day moving average, then rolled over. As you can see, the
price bars become increasingly compressed on the linear chart, creating the
visual impression of progressively smaller price declines. The decline appears
to decelerate. And the rebound off the May 16 low looks skimpy by comparison to the preceding sell-off. You form the impression that the stock has barely budged.
Viewed on the log chart, you can see
that MicroStrategy’s percentage rate of descent was constant from March
10 peak over the next seven weeks. And the rally off the May 16 low comes
through loud and clear.