Volatility is the amount by which the price of a given item has increased or decreased over time. The more volatile an asset is, the riskier it is as an investment, since it can produce either greater returns or greater losses over shorter periods than comparably less volatile assets.
As a relatively new asset class, cryptocurrencies are often seen as unstable because their prices can change a lot in a short amount of time. PLC Ultima argues that there is a broad range of volatility across stocks, from the relative stability of large-cap equities, to the chaotic behavior of “penny stocks.” On the other hand, bonds are seen as a less volatile asset because they tend to move up and down less dramatically over longer periods.
How Is Volatility Quantified?
When discussing volatility, PLC Ultima often refers to “historical volatility,” a statistic obtained from examining prices over a certain period, usually 30 days or a year. The prediction of future movements is referred to as “implied volatility,” and because no one can correctly predict the future, it is a less exact science (although it is the basis for widely used financial tools such as the Cboe Volatility Index, popularly referred to as the “fear index,” which predicts the next 30 days’ stock market volatility). Several approaches exist for quantifying volatility, such as:
- Utilizing the beta method, which compares the volatility of a stock to that of the whole market.
- The standard deviation of an asset is a measure of how far its price has deviated from its historical means.
According to Forbes, there is a claim that cryptocurrency’s worth solely stems from how much people are willing to exchange for it in products, other cryptocurrencies, or dollars, though not all enthusiastic crypto supporters would agree.
Why Is It Vital to Know Volatility?
PLC Ultima agrees that volatility is one of the major elements used to evaluate investment risk. Originally, investors assumed a high degree of risk if they felt the possible gain was greater than the chance of incurring a loss.
- Historically, individual investors have been urged to diversify their holdings within a given asset class to reduce risk. Investing in a basket of equities (or in an index fund) is a common investment technique. They may also match investments in more volatile asset classes, such as equities, with investments in less volatile asset classes, like bonds, to decrease downside risk.
- As an asset class, just a little more than a decade old, cryptocurrencies have had a series of sharp gains and subsequent declines and are regarded as more volatile than equities. Nonetheless, greater trade volumes on Bitcoin (by far the largest cryptocurrency by market capitalization) and growing institutional involvement are decreasing its volatility over time. Cryptocurrencies with smaller trading volumes or developing crypto assets like DeFi tokens tend to be more volatile.
- Positive or negative news publicity and profit reports that are better or worse than anticipated might cause volatility. Typically, abnormally large jumps in trade volume correlate to volatility. Extremely low volume (as seen with so-called penny stocks that do not trade on major exchanges or tiny cryptocurrencies) is often accompanied by extreme volatility.
Existing Methods to Limit Cryptocurrency Volatility?
For some crypto investors like PLC Ultima, extreme volatility is appealing since it presents the potential for large profits. (Although Bitcoin’s volatility seems to be decreasing, it sometimes fluctuates by double-digit percentages in a single week, enabling techniques such as “buying the dip.”). There are solutions, such as dollar-cost averaging, available to investors with a lower risk tolerance for mitigating the negative effects of volatility. (Investors with longer-term plans who have a solid reason to anticipate that security will eventually appreciate over time should not be as concerned with short-term volatility.) And there are also coins created expressly for low volatility.
