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As if traders didn’t have enough to think about already, did you know that there are two different styles of charting calculations you need to consider before analyzing short- and long-term charts?

That’s right!

When looking at charts from a short-term perspective, you’re probably using a linear chart, which is the default setting on most charting platforms.

Since linear charts are best suited for displaying short-term data, this is the reason why most platforms start you off with them.

When zooming out, though, to gather as much information above where a stock has been over the long term, you should consider switching to something called a logarithmic chart.

Trust me when I tell you that the difference between the two is often night and day.

I’m about to show you how these charts are calculated, the different stories they tell, and how to adjust your charts to reflect these calculation changes.

Linear vs. Log (Logarithmic) Charts

I know that life is busy and that you’re constantly finding yourself having to absorb seemingly endless amounts of information.

But as most experienced traders will tell you, to grow as a trader you must take the time to fully understand all of the different aspects of your chosen trading style.

Before a trader can even begin to dissect a stock chart, he or she needs to understand the difference between linear and a logarithmic scale.

Linear Charts Explained

On a linear scale, all whole numbers are equidistant from each other.

For example, the distance between $1 and $2 is the same as the distance between $56 and $57.

This can create problems for securities that have seen huge price moves.

Essentially, linear charts INDICATE? underrepresented price changes made when the security price is low (relative to the rest of the prices on the chart) and over-representing price changes when the security price is relatively high.

Logarithmic Charts Explained

A logarithmic chart is scaled quite differently.

In this case, the numbers are not equally spaced distance-wise.

Instead, they are equally spaced in terms of percentages.

For example, the distance between 10 and 20 is the same as the distance between 20 and 40.

What this means on a stock chart is that a price bar representing a 50% gain will be the same size no matter where it appears.

These charts help put large dollar moves in context and are particularly useful when stocks that have grown exponentially.

An easy rule of thumb is to use a log chart once a security has doubled on the chart.

Linear charts can often mislead on exponentially growing securities.

Whoever came up with the expression “a picture is worth a thousand words” was probably referring to this subject.

So, let’s look at an example.

On Figure 1 below, we see two charts.

The top chart is a linear chart of Novavax, Inc. (NVAX), while the bottom chart shows a logarithmic chart of the same stock over the same timeframe.

Figure 1

I’ve annotated the most glaring point of comparison, which is the period when NVAX surged nearly 5000% from its 2019 lows to its 2020 highs, on a combination of favorable Influenza and COVID-19 vaccine data.

I’ve also annotated the next big vaccine-related rally, when the stock rose 310% from its November 2020 low to its February 2021 high.

You’ll notice that on the linear chart, these rally cycles appear to be pretty equal.

However, it’s the logarithmic chart that tells the real truth, with the 2020 rally cleary dwarfing that of the 2020 to 2021 rally.

How to Switch from Linear to Logarithmic Scale

In popular charting applications like Tradingview and Stockcharts.com, you’ll take the following steps:

In Tradingview, simply right click in the right-hand margin of a chart and select Logarithmic, as shown on Figure 2 below.

Figure 2

For Stockcharts.com, simply look below the chart and you’ll see a button that allows you to turn on Log Scale, as shown below.

Figure 3

In both cases, just remember to switch back to linear scaling for your usual shorter-term charting when you are done using the log charting.

Bottom Line

Both systems have their advantages and disadvantages.

Traders looking to capture short-term price movements or analyze trading ranges may prefer linear scales for price purity.

Chartists interested in trends and long-term price histories will likely prefer logarithmic charts.

Log scale is best used when prices have moved a significant amount, no matter the direction.

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.

Well, today sure sets us up for a fun week ahead, right?

Following a sell-off on Friday, the SPY is down over 3% in the last two sessions.

VIX – the volatility index and its tradeable derivatives – VXX and UVXY – are having a bit of fireworks as well – something we haven’t seen in a while.

Now, I’m normally not the type of guy to call out market tops… I’m a Raging Bull after all!

But days like today may get people nervous and rightfully so – having been nothing but up for pretty much a year and a half, the market may sure give us at least a pull back.

Here’re 3 names I’m watching to play for the downside:

NIO Inc – NIO

  • Market Cap: 71.57B
  • Free Floating Shares: 1.35B
  • Short Interest: 4.6%
  • ATR: 2.50

I think it’s fair to assume I don’t have to explain what NIO is – the “Tesla of China” has been one of the most popular stocks over the past year.

There’re a few things I appreciate about this name:

  1. A pop and immediate fall to above $50 a few months back
  2. An immediate dip and hold to below $45 – an area was previously resistance turned support
  3. Complete failure to move higher with the market over the past 2 weeks

The stock looks like it just needs to go down some more and should everything sell off – I don’t see why NIO can’t lead the way lower.

The stock looks like it just needs to go down some more and should everything sell off – I don’t see why NIO can’t lead the way lower.

I’m interested in pops under $45 for a flush trade to $35 and under.

Fiverr – FVRR

  • Market Cap: 7.52B
  • Free Floating Shares: 29.38M
  • Short Interest: 6.55%
  • ATR: 10.94

Fiverr is an online marketplace for gigs and freelance services.

It doesn’t enjoy nearly the fame (or infame) of NIO, but the fact you likely never heard of it couldn’t stop the stock from being one of “COVID darlings”.

It went from $20 early last year to a high of $336 this February.

Much like NIO, the name has retraced since, failed a breakout and has been unresponsive to the marker’s upticks.

I really want to see it not be able to hold $200 for more drift to $150 and lower.

Crocs, Inc – CROX

  • Market Cap: 7.55B
  • Free Floating Shares: 63.70B
  • Short Interest: 4.96%
  • ATR: 4.01

I’m going to bet you didn’t see this one coming?

The maker of eponymous sandals has been one of the strongest performers of 2021 and hasn’t looked back in… well, feels like forever!

Now, I generally don’t short strongest stocks, but:

  1. The business sure has been good, but does it justify the nearly 3x pre-COVID valuation?
  2. As I said, the stock literally hasn’t had a pullback in forever
  3. Over the past few weeks, it had multiple failed breaks higher
  4. The risk/reward is very good at these levels

Now I’m not convinced yet, but I consider any protracted hold below $110 as bearish.

If weakness starts to maintain, I’m looking for a trade to $100 and eventually to old support in the $80s.

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.

It’s a market phenomenon that dates back to the early days of trading and to this day remains one of the more difficult concepts for many new traders to grasp.

“Buy the rumor, sell the news” is an age-old mantra that has left countless traders holding the bag. The emotion often leads novice traders to ignore the mean reversion forces that usually cause a stock to fall after anticipated news has been announced.

If you think about it, when a company’s stock price rallies on expectations of a corporate development that promises to strengthen the company’s financials well into the future, it can seem counterintuitive to sell the stock when the news becomes official.

As traders, we must respect the fact that stock prices move cyclically, overshooting some central mean to the upside and downside as a long-term price trend develops, in a manner that resembles something similar to what’s shown on Figure 1 below.

Figure 1

Whether it be the anticipation of strong sector-wide earnings, a beneficial change in government policy, a stock-friendly decline in interest rates, or the rumor of some new revenue-generating business line, there’s no shortage of fundamental narratives that cause these shorter-term overshoot cycles to develop.

The key thing to be able to recognize as a trader is when these cycles have run their course.

I’m about to show you how to identify when a rumor-driven price rally may have run its course to the point where, at a minimum, placement of high-probability time decay (theta decay) trades should be considered.

Traders “sell the news” of Virgin Galactic’s historic first space tourism flight

On July 11th, Virgin Galactic (SPCE) completed the world’s first space tourism flight.

But the company’s stock plummeted nearly 40% in the wake of that event this past week, as the achievement of this highly anticipated goal caused the mean reversion process that actually began 2 weeks earlier to accelerate.

As traders, we must learn to control our emotions, and part of that learning process includes not chasing stocks when they’ve moved too far from the mean.

Traders are equipped with statistical tools like Bollinger Bands to help them gauge when a stock’s price has moved too far, too fast, thereby increasing the potential for the stock to correct back toward the mean.

As Figure 2 below shows, this was the case in late June for SPCE, when the stock surged 4 standard deviations above the 50-day moving average.

Now, you’re probably wondering why I chose a 50-day moving average and +/- 4 standard deviation bands vs. the default Bollinger Band settings of 20-day moving average and +/- 2 standard deviations.

First of all, it’s because I am trying to capture longer-term cycles, and the 50-day line allows for more upside expansion than the default 20-day line.

Secondly, it’s because every stock has what can be considered its own fingerprint, which is to say that every stock tends to move with its own volatility characteristics.

As Figure 2 below reveals, since the early part of 2020, which is when the stock really started to become active, SPCE’s strong up-cycles have always stretched up to around 4 standard deviations above the 50-day line before some degree of mean reversion starts to take effect (see red circles).

Fast forward to the most recent cycle that topped on 06/25, we can see once again that this was the starting point for the latest correction.

Figure 2

Make no mistake; hindsight is always 20/20, and for anyone to say that it would have been easy to pick the top as the stock was surging to multi-month highs on 06/25 would be kidding themselves.

Taking bets against the prevailing trend is hard.

That’s why we must learn to develop the patience necessary to wait for a number of factors to come together in a way that creates a higher probability setup, and part of that higher probability setup includes the use of one of the highest probability options trades.

I’m talking about a vertical credit spread.

How the recent “sell the rumor” setup favored the use of a bear call spread

Vertical spreads are favored by many options traders for a number of reasons.

First, they benefit from the passage of time.

Next, they are profitable if the price moves in the trader’s favored direction, sideways, or even if the stock moves a little bit against the trader’s favored direction.

Finally, they offer defined risk.

The maximum gain that can be earned from a credit spread is the net credit, realized when both options expire out of the money.

The maximum loss potential is the difference in strike prices – net credit. Realized when both options expire in the money.

Now, while it is true that a trader is limiting his or herself in terms of potential profitability, given that the maximum profit that can be made is the credit received from creating the spread, these trades offer a much greater probability of success, since the selling of spreads makes the passage of time an options trader’s friend.

In the case of SPCE, I alerted readers to the $50 / $55 bear call spread this past Monday morning, with expectations of the stock entering a cool off period as the “fast money” leaves the stock in the wake of the historic first tourism space flight on 07/11.

Now, at the time, there was no indication that the price of SPCE was going to collapse as hard as it did.

Remember, hindsight is 20/20.

However, there was enough evidence to speculate that the bullishness that caused SPCE to rally 4 standard deviations above its 50-DMA had become exhausted, and that, at a minimum, a meaningful degree of upward price deceleration should follow.

As figure 3 below uncovers, that evidence grew even stronger on Monday, when SPCE confirmed a small top by closing below the bottom of the post-06/25 distribution range (see red arrow on the chart below).

Figure 3

Bottom Line

Placing trades that bet against a strong trend (i.e., countertrend or mean reversion trading) is not easy, especially in the early stages of learning to trade.

That’s why it’s often beneficial to use higher probability options strategies like credit spreads to express your countered view in these situations, rather than straight puts (when you’re feeling bearish) or straight calls (when you’re feeling bullish).

Even when a trend appears to be stalling, as was the case with SPCE this past Monday, in real-time when markets are moving it still takes skill to be able to build a countertrend position without suffering too much pain in the early stages.

Therefore, learning how to take an initial overbought signal like the extreme 4 standard deviation move discussed earlier and combining that with a trend reversal signal like the range breakdown shown on figure 3 is an important step in learning how to better time higher probability entry points.

 

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.