Bubble or…?

Charts can deceive us. The same market displayed on different scales can distort our opinion on whether the trend is up or down and how strong the trend is. In this short article, I compare and contrast the look and feel of the stock market prices on both linear and logarithmic scales.

S&P 500 Index — Linear scale

The linear chart below looks and feels like a bubble. We see the parabolic nature of the uptrend and think “I’ve seen this pattern before (in 2008 Crude Oil, 2011 Cotton, 2000 NASDAQ and others)”. In linear-scale charts, early data cannot tell it’s story. From 1900–1980, we cannot get any feel for the ups and downs. To get the real story, you have to calculate the hard numbers; doing this, you discover the -80% loss in the Great Depression; the -46% drawdown from 2000–2003; the -52% loss from 2007–2009.

Losses that make you sick do not market very well on linear scale charts. Instead, they look like slight setbacks in an otherwise perpetual uptrend.

Today, some people might look at this and think “the bubble is going to burst soon”. And hey maybe stock prices will roll over at some point, but let’s see if you change your mind when looking at the same price series on a logarithmic scale.

S&P 500 Index — Logarithmic scale

This one doesn’t look and feel like a bubble does it? Unlike the “bubble” chart, the logarithmic chart below might leave you feeling that the stock market could rally another 100% to the top green up-sloping line. Here we can get more a feel of the ups and downs, especially in the early data. We can see the tail end of the post-Great Depression recovery (1929 top to new highs in 1954); the long sideways slog that is the 1960s and 1970s; again from 2000–2014.

Charts distort our opinions and feelings about markets. Personally, I prefer to get my hands on the daily price data and not use charts at all. With the hard data, I can test different ideas and theories; not be swayed by the look of the chart or have to worry about whether the market is in a bubble or not.

Chart credit: Raoul Pal


Past Performance is Not Necessarily Indicative of Future Results
There is always a risk of loss in futures trading.

This communication is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial product, an official confirmation of any transaction, or as an official statement of Melissinos Trading LLC. All information is subject to change without notice.

These charts show examples of trends. Inclusion of a chart as a trend example does not imply any kind of recommendation to buy, sell, hold or stay out.

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