The degree to which the value of an item has increased or decreased over a certain period of time is referred to as its volatility. In general, the more volatile an asset is, the riskier it is perceived to be as an investment. This is because the more volatile an asset is, the more potential it has to deliver either bigger returns or higher losses over shorter periods of time than assets that are comparably less volatile.
The degree to which the value of a certain asset has increased or decreased over a specified period of time is referred to as that asset’s volatility. In general, the more volatile an asset is, the riskier it is perceived to be as an investment. This is because the more volatile an asset is, the more potential it has to deliver either bigger returns or higher losses over shorter periods of time than assets that are comparably less volatile.
As a relatively new asset class, cryptocurrency is usually seen as being very volatile, with the potential for huge price changes in either direction over relatively short periods of time. It is generally agreed that stocks have a broad variety of levels of volatility, from the relative steadiness of large-cap companies (such as Apple or Berkshire Hathaway) to the sometimes unpredictable behaviour of “penny stocks.” Bonds, on the other hand, are seen as being an asset with lower volatility, and their price movements tend to be less extreme, both upward and downward, and they take place over more extended periods of time.
When individuals discuss the concept of gauging volatility, they are typically talking to “historical volatility,” which is a statistic that is produced from an analysis of price trends over a particular time period (often 30 days or a year). The prediction of future movements is referred to as “implied volatility,” and because nobody can actually predict the future, it is a less exact science (although it is the basis for widely used financial tools like the Cboe Volatility Index, which predicts the next 30 days’ stock market volatility and is nicknamed the “fear index”). There are a few approaches that may be taken to quantify volatility, including the following:
You may utilise a technique known as beta, which determines how volatile a particular stock is in comparison to the overall market (the typical benchmark is the S&P 500).
You have the ability to determine an asset’s standard deviation, which is a measurement of how significantly its price has deviated from its historical average.
When determining the level of investment risk, one of the most important elements to consider is volatility. Traditionally, investors would take on a high level of risk if they feel the potential benefit is worth the possibility of losing part of their investment. This belief is based on the likelihood that the potential reward will outweigh the probability of losing some of their investment. (Or all of their investment, like in the recent instance of high-risk hedge fund manager Bill Hwang, whose entire $20 billion dollar fund vanished in just two days.)
As a method of mitigating risk, diversification within an asset class has traditionally been recommended as a course of action for ordinary investors. Rather of investing in a select few companies, a common tactic is to purchase shares in an index fund or a diversified portfolio of companies. They may also match investments in riskier asset classes, such as equities, with investments in riskier asset classes, such as bonds, in order to decrease the possibility for loss even more.
Cryptocurrency is an asset class that is just a little more than a decade old, and it has witnessed a series of sharp rallies and subsequent losses. As a category, cryptocurrency is believed to be more volatile than equities because of its short history. Having said that, it appears that greater trade volumes on Bitcoin (which is by far the largest cryptocurrency by market size) and more institutional participation are lowering its volatility over time. Cryptocurrencies with smaller trading volumes or new cryptoassets like DeFi tokens tend to have more volatility; therefore, it is important to only risk quantities that you can afford to lose while playing with these assets as a novice.
Positive or negative news coverage, as well as earnings reports that are either better or worse than expected, are examples of factors that might boost market volatility. Volatility is almost always accompanied by very high surges in the volume of trading activity. High volatility is typically correlated with very low volume, such as that observed in the case of so-called penny stocks that don’t trade on major exchanges or tiny cryptocurrencies.
The high degree of volatility that crypto assets are subject to is one of the selling points for some investors since it opens the door to the prospect of lucrative returns. (And despite the fact that Bitcoin’s volatility appears to be decreasing, the cryptocurrency’s price sometimes shifts by tens of percentage points in the span of a single week, making it possible for trading tactics such as “buying the dip.“)
There are investment methods, such as dollar-cost averaging, which may be used to mitigate the negative effects of volatility on portfolios held by investors with a lower risk tolerance. (In general, investors who have strategies that are more long-term and who have strong reasons to believe that an investment will ultimately increase in value over time do not need to focus as much attention on short-term volatility.) Stablecoins, such as USD Coin and Dai, are cryptocurrencies that have their prices tied to a reserve asset such as the U.S. dollar. These cryptocurrencies were developed expressly to have minimal volatility, thus the name stablecoins.
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