Volatility is a common if not central concept in trading, so what does it mean in the cryptocurrency market? More so, how to read it in order to benefit from it is what every trader wants to know.
Volatility is one word that traders of every asset in the world hear on a daily basis, but no one hears about it more than cryptocurrency traders. That’s no coincidence, as crypto is where the volatility is at its highest.
Of course, volatility is not limited to crypto only, but it has grown to play such a massive part in the industry that an entire culture has developed around it. In this article we tackle volatility to see how it works, what causes it, and mostly, how you can use it to your advantage as a cryptocurrency trader.
What is Volatility?
Let’s start with a simple explanation. Volatility is used in the trading industry to describe the movement, or fluctuation, of an asset’s price. Any asset available for trading, regardless of whether we are talking about crypto or traditional financial assets, is volatile. That’s what makes it profitable to buy or sell, depending on which way the price moves. But the fact remains — all assets see prices go up and down.
Some assets see their prices generally move up and down only slightly. For example, gold’s value as a wealth preserver is perceived in its long-term stability, relative to other investable assets. Provided, of course, there was no major event to disrupt the price more actively (even so, gold tends to outperform during crises).
Cryptocurrencies, on the other hand, are decentralized, and they are not backed by any real-world asset that would secure their prices (other than stablecoins). This makes their volatility much higher, as it responds to supply and demand, but it also reacts strongly to any new development in the industry.
What Causes It?
Speaking of strong reactions, what causes the volatility in cryptocurrencies? Generally, there are several factors that can cause the price to fluctuate, but it all comes down to positive and negative news and developments.
For example, if there is a positive development in the crypto industry — a new major partnership, the entrance of a major traditional company into crypto, an increase in demand, new technological development, a new use case, block reward halving, or anything of the sort — price is likely to see positive movement.
This happens because the assets in the crypto industry are only as valuable as people think they are. So anything that would increase the scarcity of crypto — typically by signaling that new investors are coming after the coins — is likely to play on the investors’ desire for profit and cause them to hoard coins. In doing so, they increase the demand, and in turn, crypto prices.
Of course, the opposite is also true, and any negative developments cause people to sell their coins in order to secure profits before the price starts dropping. But, by selling, they are increasing the supply of available coins, making them less scarce, and causing their prices to drop. Traders are, of course, well aware of this. However, this doesn’t change things, as it is all about racing to be the first one to do it, and get the most money out of the dropping prices.
How to Read Volatility?
Crypto volatility is not as easy to read as it is in traditional markets. In the traditional asset trading world, there is what’s known as the volatility index, or VIX. This is a way to define the current volatility, and differentiate healthy volatility from extreme volatility.
It is measured by the CBOE Options Exchange, and it functions as a scale whose value goes between 12 and 20, where 12 is considered low volatility, while 20 is considered high. So to determine how volatile prices are, all you need to do is look up these values, and look at the asset charts, and you will have a pretty good idea of what’s going on.
Things work differently in crypto markets. Volatility is always fairly high, with prices regularly going up or down by 5%, 10%, 20%, and for some assets, even more. You can never tell where the price is going next just by looking at the flickering figures and charts. You must always keep an eye on the news, popular trends, crypto community interactions, project developments, company partnerships, reputation, and much more. Of course, these same things also cause volatility in traditional markets, but in crypto, they tend to have a much more powerful impact.
Let’s not forget the price movement of Bitcoin itself. The first and largest cryptocurrency is so dominant that it constantly dictates the price behavior of other assets. If Bitcoin price is seeing a severe drop, most cryptocurrencies tend to follow, regardless of their personal developments and news. Naturally, this is quite overwhelming, which is why crypto trading is so risky.
Correlation Between Volatility and Reward?
All that said, you might wonder why people do it. Why do they trade crypto, given how volatile and risky it is? The answer is simple: the potential reward.
While high volatility is high risk — as you stand to lose a large portion of your investment by buying at the wrong time — trading an asset that can rise by a large percentage at any given moment for any reason can be rewarding. This high potential for earning can give a trader reason to risk their funds; the thinking is that since crypto moves quickly and constantly, there is always the potential to earn.
Even when the market is extremely bearish, some traders turn to crypto CFDs (contract for difference) or other derivatives that allow them to try to make a profit by predicting any given crypto’s price movement. Accurately predicting the prices of crypto can be an invaluable skill; if done right, with the help of charts and analysis tools, the potential for earning becomes immense.
Healthy volatility is always there, even when prices are relatively stable. However, extreme volatility, which occurs once or twice each decade in traditional markets, can be encountered almost yearly in crypto markets.
Where to from Here?
Given the strength of crypto volatility and the overall market’s unpredictability, it is difficult to say what awaits down the road. Yet most investors are somewhere between confident and positive about crypto’s future. The past two years have seen the industry starting to accept regulation while making strides in attracting institutional investment, seeing greater adoption than over the previous decade combined.
That overall confidence has been strongly reflected in cryptocurrency prices, for example, pushing Bitcoin from $3,700 at the end of 2018 to an all-time high of $64,800 in April 2021. If you were to buy Bitcoin in 2018, when many said the bubble had burst, you would have been rich by the early days of May. But by the end of May, you would have lost nearly 50% of your crypto earnings due to a massive price drop. Now that’s volatility.
Ultimately, cryptocurrency is a very sensitive market that requires your full attention and solid discipline with a keen eye on prices and new developments. Not to mention deep knowledge and skill when it comes to price predictions.
All of it can be overwhelming at first, but keep studying it and watching how new developments affect the market, and you will eventually learn how the market breathes and what to expect under different circumstances. By then, volatility becomes just another factor to manage, rather than an obstacle to fear.
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Note: BTSE Blog contents are intended solely to provide varying insights and perspectives. Unless otherwise noted, they do not represent the views of BTSE and should in no way be treated as investment advice. Markets are volatile, and trading brings rewards and risks. Trade with caution.