The essential charts
In this section, we will explain what a chart is, what they are used for and we’ll discover the most important types of charts that we will see all throughout this course and in real life.
What is a chart?
A chart is simply a graphical (visual) representation of data. Charts are really versatile and they can “paint a picture” of (represent graphically) almost any data, for example, you can make a chart representing your weight changes over a period of time, or you can show what planets are closer to the Sun. The options are almost endless. The data we choose will be represented by some visual symbols, depending on the type of chart, such as bars, lines, dots, or slices.
Types of charts in finance
Here we will go over the main types of charts that are used in the finance world, which we will use throughout this course. Keep in mind that there are many more types of charts used for other purposes. Here are the five main ones used in finance:
The line chart
The line chart is the most popular and basic type of chart used in finance because it is ideal for analyzing trends. The price of an asset (like a stock or a bond) changes over time; therefore, we use charts to represent those fluctuations. The line chart is the easiest way to visually represent an asset’s price history by using a single, straight line that connects each price point. Don’t worry if you don’t know what stocks or bonds are, we will explain them later. Below is an example of a simple line chart:
From the above chart, we can distinguish three essential elements:
- The axes are the horizontal and vertical lines that contain units of measure.
- Vertical axis (blue): also called the y-axis, they represent the price of one stock in US Dollars ($). This graph’s range goes from a low of $0 (bottom) to a high of $25 (top). It is broken down in intervals (increments) of $5, but you may find line charts with different intervals (like $10 or 10 cents, or even 1 cent). Different intervals and ranges are used to make the line charts easier for the audience to read.
- Horizontal axis (green): also called the x-axis, they represent time in years. This graph’s range goes from 2012 (left) to 2019 (right).
This chart’s axes are used to represent what happened to the price of a stock (vertical axis) every year (horizontal axis). The rectangles in between both axes are used to make it easier for the audience to follow the graph.
- The actual line (orange) depicts the data points we are trying to show. In this case, it represents the price of a stock (vertical axis) every year (horizontal axis). For instance, if you want to know what the price of the stock was at the end of 2012, you can follow these 3 simple steps:
- Simply look at the horizontal axis until you find 2012
- Then, move your eyes up vertically until you find the orange line
- Finally, move your eyes to the left horizontally to see the price, which is $10
Try it yourself with another data point. With a little bit of practice, it will become so easy that you won’t have to follow these steps.
- The legend shows the name of each data set represented in the chart. In our example, we can find it at the bottom, center, under the x-axis. It displays the color and shape of the line and assigns it a name; in this case, “Price of a stock” is the name of the line, it explains what the line represents. There may be multiple lines in a chart, and the legend is useful to help you distinguish which one represents which item.
The bar chart
Bar charts are really useful due to their versatility, as we will see now. A bar chart typically presents categorical data with rectangular bars with heights or lengths proportional to the values that they represent. The bars can be plotted vertically or horizontally, and they can also be stacked, as we will see.
- The vertical chart‘s x-axis (horizontal) shows all the categories that you want to compare and the y-axis (vertical) represents the values you are showing (in business, it will most likely represent some money figure like revenue, for instance). Let’s see an example:
Imagine you need to show to your boss what the revenue, the expenses and the profit were for the past three years at your company. A bar chart would probably be best in this case, below you will see how it would look like:
The x-axis shows each of the three years, the y-axis represents the dollar values of the data, and the bars (or columns) represent the actual data you have to show your boss, the company’s Revenue, Expenses, and Profit. The chart legend is located at the top and it is showing that the revenue values is represented by the blue bars, the expenses by the orange and the profits by the green. Let’s focus on 2018 to make sense of the chart: following the technique we used for the line chart, look at 2018 and then move your eyes up until you see the end of the blue bar (revenue); then, move your eyes to the left until you reach the y-axis to see it’s dollar value, which is $210,000.
- The stacked vertical bar chart is a great tool when you need to convey a lot of information in one chart, as it shows the values of all categories stacked on single columns. The chart below shows 10 countries and their GDP (not real numbers):
Trying to show this much information in a vertical bar chart wouldn’t be ideal, it would look kind of messy. By using a stacked bar chart, we can easily see the total GDP change year over year, and we can get a visual idea of the comparative size of those countries. The main disadvantage is that the data isn’t shown as clearly as in other types of charts.
- The horizontal bar chart solves the main problem you may find when trying to use a vertical bar chart, which is that there isn’t much room at the x-axis to display the category labels if they are long. Below is an example of what a horizontal bar chart would look like:
If you have many categories to display, and their names are somewhat long, you may want to use a horizontal bar chart, as it offers more room and it is easier on the eyes.
The pie chart
Pie charts are widely used in the business and finance world; however, Business Insider and other sources explain that they have been criticized by experts due to the difficulty to compare different sections of the pie chart or to compare data across different pie charts. It is often recommended by experts to replace pie charts with other types such as bar charts (coming up next). Nevertheless, you will likely find pie charts at some point in your life, so it is important to understand them.
A pie chart is a circular graphic with no axis that is used to compare the sizes of certain categories in a group, and it is divided into sectors (or slices). Each slice takes a different color (so it is easier for the audience to distinguish among the categories), and it represents a category in a data set. The size of a slice is proportional to the size of the category it represents as compared to the other categories in the group; in other words, the bigger the slice, the bigger the category it represents in comparison with the others. It is called a pie chart because it looks like a pie that has been cut up into slices (sectors). Let’s look at an example to make it easier to understand:
Imagine your job is to sell cars and you have to show your boss the comparison of sales among the four types of cars (categories):
- Car A –> Sold 100 cars
- Car B –> Sold 150 cars
- Car C –> Sold 180 cars
- Car D –> Sold 70 cars
Total number of car sales –> 500 cars
A good way to impress your boss would be by showing her the car sales data you collected above in the form of a pie chart:
The entire circle to your left represents the total number of car sales, which is 500 cars. You will notice that the circle (you can think of it as a whole pie) is divided into four slices, and each one has a different color. Each slice represents the number of sales for each type of car as a percent of the total:
Car A (the blue slice) represents 20% of the total cars sold: 100 Cars A sold / 500 total cars sold x 100
Car B (the orange slice) represents 30% of the total cars sold: 150 Cars A sold / 500 total cars sold x 100
Car C (the green slice) represents 36% of the total cars sold: 180 Cars A sold / 500 total cars sold x 100
Car D (the yellow slice) represents 14% of the total cars sold: 70 Cars A sold / 500 total cars sold x 100
You can make pie charts out of almost any categorical data. Try it yourself, ask 10 people what their favorite color is, or anything that can be divided into categories, and try to make a pie chart with the data you collect.
The scatter plot
A scatter plot is a chart that uses dots to represent the values of all data points for two different numeric variables. Let’s look at an example to show how they work:
The above chart shows us how many bags of chips were sold last night at a movie theater (Quantity sold) compared to their price. Each dot represents the relationship between the price of a bag of chips (y-axis) and the amount that was sold (x-axis). For instance, we see that only 2 bags were sold that cost $10/bag, or 7 bags were sold that cost $2/bag. Scatter plots are great tools to observe relationships and trends between variables. In this example, we see that the pricier chips tend to sell less than the cheaper ones.
We will revisit this type of chart in our portfolio optimization section, and you will also find it in our portfolio reports to show you the relationship between millions of possible portfolios -more on this later.