What is volatility?
Volatility is a measure of how the price of an asset changes over time. Assets that are volatile have the potential for big returns as well as big losses, they are a higher risk investment.
High volatility means prices are moving up or down quickly and steeply.
Volatility is typically measured by looking at prices over a set period of time such as 30 days or one year. Some tools attempt to predict future volatility trends.
For example, the Chicago Board Options Exchange’s Volatility Index forecasts stock market volatility for the next 30 business days using option prices from stocks in the S&P 500.
The concept of volatility is very relevant to cryptocurrency. Cryptocurrency is more volatile than other assets with major upward and downward movement in short windows of time.
Cryptocurrency prices fluctuate because they are influenced by factors like investor sentiment, supply and demand and information being shared in news media and social media. Volatility is also due to the digital nature of cryptocurrencies and the fact that there is a low level of regulation.
In comparison, the stock market experiences a range of volatility – there are stable stocks as well as so-called “penny stocks” that are known for being more unpredictable. Bonds are an example of an asset with lower volatility.
Volatility can be a good thing if increases or decreases in price are steady and stay within a general range. It can also be extreme, with sudden price movements up or down. Healthy volatility can create opportunities for profit such as enabling traders to buy low and sell high.
Understanding volatility is important, because it means understanding investment risk.
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How is volatility measured?
There are several ways of quantifying volatility. One is calculating the standard deviation of the return of an asset over a set period of time. That measures how much the price of an asset has changed compared to its historical mean.
Another method is called beta, this measures how volatile a specific stock is relative to the market – typically, the S&P 500 is used as a benchmark.
Several indexes exist specifically to measure the volatility of major cryptocurrencies including the BitVol Index and EthVol Index, which measure the 30-day implied volatility for Bitcoin and Ethereum respectively.
Indexes exist within traditional markets to help measure and possibly anticipate future volatility levels. The American stock markets use the Volatility Index (VIX), created by Chicago Board Options Exchange (CBOE). VIX uses option prices from S&P 500 stocks to measure market volatility over a 30-day period. CBOE also created a volatility index for U.S. 10-year treasury notes in 2014, measuring investor confidence and risks in bond markets.
What does volatility look like in cryptocurrency markets?
Cryptocurrency is more volatile than other assets. Data shows the price movement in the cryptocurrency market is more rapid than the main market.
It is possible for two people investing in the same cryptocurrency to have drastically different outcomes with one making money and the other losing. Timing plays a big role in these outcomes.
For example, In 2016, the price of Bitcoin jumped 125 per cent, followed by a rise of 2,000 per cent in 2018. Bitcoin’s 2017 peak saw it surpass all-time records. The price then fell, before Bitcoin hit new all-time highs in 2021, more than tripling the 2017 peak Bitcoin saw during its bull run.
These price swings can be caused by news developments, speculation, even social media comments. High volatility and low liquidity feed off each other and create a dangerous combination..
Excerpts say volatility in cryptocurrency may decrease over the long term due to factors like widespread adoption, market growth and the potential for increased regulation.
There are already signals that some of the volatility in the cryptocurrency market is waning as investors and trading firms gain confidence in this asset class. There is also a growing market for derivatives for cryptocurrencies that will be developed and expanded to support the broader system.
Are there ways to make cryptocurrency less volatile?
High volatility is often a big part of what attracts cryptocurrency investors, because there is the potential for big returns.
However, there are ways to lessen volatility for investors who have less risk tolerance.
For example, stablecoins are a less risky option. Stablecoins are a type of cryptocurrency that have their price linked to another asset class, such as a commodity like gold. This helps keep the price stable. Stablecoins can be fiat-backed, commodity-backed, cryptocurrency-backed or algorithmic. They are a good option for investors who want an asset that behaves like fiat currency, but has the flexibility of cryptocurrency.
Another option is to use a strategy like dollar-cost averaging. This involves dividing the total investment amount and buying a target asset in intervals. By sticking to an investment schedule and investing a fixed amount regardless of the price, some risk is mitigated. It is still possible to lose money – dollar-cost averaging works best as a long-term strategy.
Experts generally advise long-term investors to ignore periods of short-term volatility – over the long run, markets tend to rise.
Volatility is an important concept for cryptocurrency investors to understand, because it is one of the primary factors used to assess investment risk.
Cryptocurrency is more volatile than the traditional stock market, which is why it is attractive to many investors – big risk can equal big rewards.
There are specific indexes used to measure cryptocurrency volatility, which can be useful tools. These include the BitVol Index and EthVol Index, which measure the 30-day implied volatility for Bitcoin and Ethereum respectively.
For those who are risk-averse, there are ways to lessen the volatility associated with cryptocurrency investing, such as using the dollar-cost averaging strategy or focusing on stablecoins.
Experts believe the volatility of the cryptocurrency space may diminish as it matures. There are already signals that volatility is lessening as investors and trading firms gain more confidence.