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Trader's Corner

The Right Trendline

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"It's gone parabolic!" traders sometimes say when a trend develops curves like this one's.

Annotated Daily Chart of VISN:

Note: Articles are first written in advance of the publication date and so charts do not depict current prices.

The curve away from the trendline is marked by the dotted red line. Some traders consider such curves to be the beginning of the end for a trend, whether that trend is an uptrend or a downtrend. A trader believing that VISN was topping would have to wait until a drop below $12.00, where a trendline drawn off the January and March lows would have crossed, to see a trendline break, however, and confirm that it had changed its trend.

Or maybe not.

Annotated Daily Chart of VISN:

Note: As this article was edited Friday, May 16, VISN had continued its climb and was at 21.40, although the day's candle was looking decidedly ugly.

A couple of years ago, I wrote an article about the differences in arithmetic and semi-log charts. I also mentioned them obliquely in a more recent article. However, fellow writer Keene Little has been talking about them in the Market Monitor, the live portion of the Option Investor site, and I thought it might be time to review them again on these pages.

Old-timer chartists sometimes suggest that you chart weekly or monthly intervals on what they call a log chart, but what they really mean is a semi-log chart. A semi-log chart is one that employs a regular arithmetic scale for the horizontal time axis but a logarithmic scale for the vertical price axis. What does this accomplish? A couple of charts point out the major difference.

Annotated Daily Chart of AA, Arithmetic Scale:

Annotated Daily Chart of AA, Semi-Log Scale:

On a chart with an arithmetic scale, equal vertical distances represent equal price changes; on one with a semi-log scale, equal vertical distances represent equal percentage changes. That can become important when measuring big moves or ones that occur over a long period of time.

Annotated Monthly Chart of WMGI:

Now that a few of the reasons why and the instances when we might use a semi-log versus an arithmetic chart have been established, it's time to follow that parabolic curve back to its apex, the beginning of the article.

When a move is a long-term one or a big one, trendlines drawn on a semi-log chart may prove more trustworthy than those drawn on an arithmetic chart. Most charting services have arithmetic charts as the default choice, but most also allow for quick switching of charts to semi-log scales and allow traders to toggle back and forth between them. Check with your charting service to determine how to go about them. For me, it's easy to toggle between one type of chart and another, and you'll probable find that it is on your charts, too.

Sometimes, particularly if the move is a big one so that the percentage gains or losses vary more than the ones depicted on AA's chart, an arithmetic chart distorts what happened.

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