You’ve Been Lied To… And It’s Time to Set the Record Straight

Delray Beach, Florida – Among serious traders, few things are more revered than a simple price chart.

It’s the best indicator of what the market is doing at any moment.

No doubt, studying a stock’s price chart – the cornerstone of technical market analysis – is an important part of the investment decision-making process.

It forces us to check our expectations against the reality of the market. Because no matter your views or assumptions, the chart speaks for itself.

But there’s something misleading about the traditional price chart…

We’ve been taught to think that it’s the only way to faithfully plot a stock’s price…

But that’s not true.

There are many ways to plot stock prices… and each has its own advantage.

There are candlestick charts… bar charts… Kagi charts… Heikin-Ashi charts… point and figure charts… and, of course, the simple line chart.

Each charting style plots the stock price. But each one also provides a different perspective on that same information.

Today, I’m going to show you a simple variation on the classic line chart that gives us a better view on price trends.

A Matter of Perspective

To get started, take a look at this price chart of the S&P 500…

Based on the chart above, novice investors might think that hardly any gains were made during this 75-year period.

They’d be dead wrong.

Investors actually made more money between 1941 and 1965 than they did between 1966 and 1991 or 1992 and 2016.

So why does the line chart present the last 25 years in such rip-roaring style? The key here is scale.

The scale used above is what’s called arithmetic or linear.

Now let’s look at the same chart from a different perspective…

This chart gives us a very different – and more stable – view of the S&P 500’s price action.

Over the same 75-year period, the S&P 500 gained more than 21,000%.

Why Log Scale Works Best for Long-Term Investors

Linear and logarithmic charts use different scaling methods on their y-axes to reflect different views of price action.

A linear chart emphasizes the change in dollar value. A logarithmic chart emphasizes the percentage change in dollar value.

Here’s what I mean…

Suppose shares of a particular stock are up $5 over the past year.

That could be a big deal or hardly anything. It all depends on our starting point… where the stock was a year ago.

If the stock was trading at $5, a gain of $5 would reflect a 100% return.

But if it was trading at $100, that would be just a 5% return for the year.

Investors should focus on the percentage gain earned on their investments, not just the change in dollar value.

Therefore, a logarithmic scale chart can better serve investors who want to see the long-term trends in the market.

While the linear chart of the S&P 500 made the market seem extreme or even overly inflated in recent years, the log chart placed its price action in the right context.

In fact, it’s evident from the log scale chart of the S&P 500 that stocks have enjoyed a rather consistent and reliable uptrend over time, in spite of the natural ebbs and flows of the markets.

Let’s take a look at another example where the standard linear chart might mislead investors.

Below is a 20-year chart of Amazon (Nasdaq: AMZN)…

Amazon has been one of the best growth stories of the 21st century. It’s one of those stocks that makes investors kick themselves for not getting in sooner.

But is it too late to get in now?

I’ve spoken to a number of folks who believe the answer is yes.

The reason? “Take a look at the stock chart,” they tell me. “It’s run up so much already!”

Of course, I always ask them… “Which chart?”

On a logarithmic scale chart, Amazon’s uptrend still looks impressive… but more importantly, it looks stable.

And if you think Amazon’s investors made their biggest gains over the last 10 years – as the linear chart makes it seem – you’d be wrong (again).

Investors made even more money in the previous 10 years, from 1997 to 2007.

That’s the psychological power of charts. They can leave the wrong impression on the minds of investors.

But if you want to be successful, sometimes all you need is a slight change in perspective.

Good investing,

Anthony