Cryptocurrencies: When Arithmetic Is A Lie

by: Jim Roof
Summary

Investors and traders buy and sell based upon percentage gains.

Understanding price movement should be based upon percentages and not 'dollars' gained or lost.

The current cryptocurrency environment is rife with arithmetic scaled charts that distort reality and mask the objective truth.

For ANY investment that has risen dramatically, logarithmic charts tell the true story and arithmetic charts should be discarded entirely.

We have all seen articles on Bitcoin, Ethereum and other cryptocurrencies, and with rare exceptions, these articles make a critical error in their depictions of price movements. I am sort of guessing here, but I would say that at least 90% of the articles I have seen use arithmetic charts as opposed to logarithmic charts. So, what is the difference and why is this difference particularly important when trying to get a handle on the movements of Bitcoin, Ethereum and the like?

First, let's look at the title of this article. There are two ways to pronounce the word 'arithmetic'. When we talk about adding, subtracting, multiplying and dividing, the second syllable is emphasized - a-RITH-me-tic. When we talk about a chart scale, it is the third syllable that gets the emphasis - a-rith-ME-tic. That is the word I am using in the title here.

So, what's the difference and why should anyone really care? First, let's ask ourselves a very fundamental question. What is it that motivates people who invest or trade in the first place? Obviously, it is desire for gain or fear of loss. But what is the MEASURE of gain or loss that is to be used? We have to quantify it somehow if we are to gain a decent understanding of people's behavior in the markets. I would argue that above all else, the measurement should be the PERCENTAGE of gain or loss. We hear investors brag about their doubles and triples and these terms refer to percentages. I have never heard anyone brag about being ten dollars up for the day in Berkshire Hathaway (NYSE:BRK.A). As of the mention of this ticker, BRK-A is up a little less than 1%. That's not horribly impressive, but what if someone told you that one of their stocks was up over two and a half GRAND? Wow! That's HUGE!... unless it is BRK-A, currently trading for just a hair under $300,000.00.

I contend that measuring price movements by percentages is by far the more accurate way to gain a perspective that makes sense. Nobody is going to sell their BRK-A because it is up $2,500.00 per share. Everyone would be a seller if Apple (NASDAQ:AAPL) gapped up tomorrow $2,500.00 to $2,672.00. In fact, a $3,000.00 movement in BRK-A is the percent equivalent of a 1.75% move in AAPL.

Look at the chart below.

Bitcoin 2017 Arithmetic Scale

This is a chart of Bitcoin for 2017. This is the chart that almost always accompanies articles that stress the 'meteoric' rise in price. This chart implies an uncontrolled, unbridled, and unsustainable rise that screams out for a crash of major proportions and is offered as proof positive that Bitcoin and, by extension, the entire crypto space is in a bubble of historic proportions. It is tulip-mania all over again. Right? Bitcoin is so completely out of control that one cannot even START to find a trend line on the chart.

Now look at this chart.

Bitcoin 2017 Log scale

Same data as the first chart. Really? But this looks like Bitcoin has been moving up in a parallel channel, not the insane moonshot that the first chart illustrates. The first chart is in an arithmetic scale in which a one dollar move from 700 to 701 is the same vertical distance as from 17,000 to 17,001. That creates an impression that Bitcoin is off-the-rails.

But the logarithmic chart, one in which a 10% movement is shown as the same vertical distance no matter where it occurs (100 to 110, 10,000 to 11,000 shown as identical magnitude), shows what appears to be a rather garden variety ascent in a controlled range. Oh, it's up BIG. No doubt about it. But these two charts, containing the exact same data, paint two different pictures. No doubt about that either.

I am not offering this as technical analysis per se. I am bringing this point to light because it is important that people get as accurate a read as possible on price movements. This is especially applicable to a very fast and heated market that the cryptocurrencies are in at this very moment.

Authors who fail to use a logarithmic scaled chart when they discuss anything that has appreciated tremendously over a relative short period of time do their readers a disservice in my opinion. They are either ignorant of the shortcomings of arithmetic scale charts or they know the difference but are willing to sacrifice objectivity while they try convince their readers that cryptocurrencies have jumped the shark and are due for a bubble pop of epic proportions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own Bitcoin, Ethereum, Litecoin, IOTA, and Trezarcoin