Stock Trading: Thinking "Ratio-Scale" and not "Interval-Scale"
Monday, February 06, 2006 Permanent link to this post
Its a simple question that many get wrong: Whats more difficult - a stock rising from $5 t0 $5.50 or a stock rising from $100 to $110 (assuming of course that underlying fundamental drivers are comparable). The answer is that both are same because its a 10% jump in both cases. Many people get this wrong because we are primed to think in "interval-scale" - what is the difference between prices? Once stock is rising 0.50 cents while other is rising $10! However, markets work on percentages - the ratio-scale. Every change must be seen in reference to the base value.
Nowhere is this thinking gap more obvious than in the charts. Almost all major chart providers (example: Yahoo! Finance) default their charts to a linear y-axis that corresponds to the interval thinking. They do provide an option to change the y-axis to a log scale which would effectively represent a ratio thinking - but I wonder how many people take the trouble of changing their settings.
So next time you are seeing a chart or evaluating a price - make sure thar you are looking at a log chart, and you are calculating percentages and not differences.
BTW: two stocks I am monitoring: Blockbuster (BBI) - I think with their new online rental program they will be able to compete effectively with Netflix. Their physical infrastructure provides them with additional competitive weapons - and considering the current prive of 3.9-something - its a good buy. However - this might need to be held for a couple of quarters before the effect is seen in financial statement and then affects the prices. Further - since the price is below $5, it has higher margin requirements - so thats cramping my liquidity situation right now.
Second stock is TurkCell (TKC) - available at PE of 8.4. This is Turkey's largest mobile provider with amazing topline and bottomline growth. I think this has great potential. I will be looking to take a position in both these stocks today.
Nowhere is this thinking gap more obvious than in the charts. Almost all major chart providers (example: Yahoo! Finance) default their charts to a linear y-axis that corresponds to the interval thinking. They do provide an option to change the y-axis to a log scale which would effectively represent a ratio thinking - but I wonder how many people take the trouble of changing their settings.
So next time you are seeing a chart or evaluating a price - make sure thar you are looking at a log chart, and you are calculating percentages and not differences.
BTW: two stocks I am monitoring: Blockbuster (BBI) - I think with their new online rental program they will be able to compete effectively with Netflix. Their physical infrastructure provides them with additional competitive weapons - and considering the current prive of 3.9-something - its a good buy. However - this might need to be held for a couple of quarters before the effect is seen in financial statement and then affects the prices. Further - since the price is below $5, it has higher margin requirements - so thats cramping my liquidity situation right now.
Second stock is TurkCell (TKC) - available at PE of 8.4. This is Turkey's largest mobile provider with amazing topline and bottomline growth. I think this has great potential. I will be looking to take a position in both these stocks today.
Labels: Investing
Therer are 0 Comments. Post a Comment
Create a Link to this post.
Technorati Authority
