Bitcoin vs Risk: Understanding Volatility
Have you ever wondered how to assess the risk associated with the fluctuations of Bitcoin or any other digital currency? Find the answer in this article.
Is volatility suitable for traders, both in the short and long run?
Volatility represents both risk and opportunity for financial investments, so let’s understand it adequately and in the easiest way.
First of all, let’s define it.
Simply put, volatility is the change in a security’s price over a given period. If the price stays relatively stable, the asset has low volatility. Highly volatile security hits new highs and lows quickly and has rapid increases and breathtaking falls.
And for those who have invested in Bitcoins over the past few years, we know that Bitcoin is explosive.
Risks and Opportunities
Did we ask ourselves what’s the risk we have taken, or the opportunities we have sometimes missed?
Let’s have a look at the Bitcoin chart:
As shown by the chart indicator below, Bitcoin price is currently moving by $3'350 per day, on average. This movement, therefore, depicts a risk, as well as an opportunity. And here we want to explain them.
There are different models to measure volatility. The one stated in this chart is the simplest and also one of the most efficient. It is called the Average True Range and is widely used in technical analysis.
It represents the historical volatility of an asset, expressed in X-periods. Classically, it uses the value 14 as standard, but any other number can be taken, if you prefer to analyse longer. It is the average of the actual ranges over the specified period. It measures volatility, also taking into account any gaps in price movement. Therefore, we can say that the ATR measures the average high-low price excursion of the chosen timeframe.
How it helps
So what help can it provide?
It helps us understand where the more reasonable closing price for our trade.
We can therefore adapt our values of Stop Loss or Take Profit according to the ATR.
At higher ATR levels, we will have wider Stop Losses and Take Profits, thus adapting our investment to the current market volatility.
Let us do something somewhat curious: let us mark the ATR values of various financial instruments:
In the first column, we indicate the current price of the security. In the second column, the current value of the ATR at 14 periods.
Next, we add a column that shows the ratio between the value of the ATR and the asset’s market price.
At the end, we perform the same task by also considering a 200-period ATR, representative of a long-term investment.
With this data available, we can draw some conclusions:
- Bitcoin has been more volatile in the short run than in the long run (ATR 14 > ATR 200). Indeed, in the chart above, we see how the ATR indicator has been soaring since late 2020.
- Bitcoin is more volatile than all the other securities listed. We have taken into account the Nasdaq (the technology sector index which is on average more volatile than the other stock market sectors); the S&P500 (the global equity benchmark); the Swiss SMI index and two currencies: the most liquid and the most volatile (EUR/USD and Turkish Lira).
- Besides, we observe that Bitcoin is almost three times more volatile than the Nasdaq in the short term (5.7% average daily excursion vs 2.0% of the hi-tech index), but “only” twice as volatile in the long term (3.6% vs 1.8%).
- Bitcoin is 10 times more volatile than the EUR/USD.
Size and risk management
Many people still think that you need $60,000 or multiples to invest in Bitcoin, which is not true. With Swissquote, you can exchange the amount of dollars you wish (e.g. $1'000), or buy as many Bitcoins as you like, even fractions of a contract (e.g. XBT 0.01).
It significantly helps in managing your portfolio risk. Whether retail or institutional, every investor can tailor his purchases to his own needs at any given time.
Key takeaways
This article shows that Bitcoin (and therefore other crypto-currencies) are more volatile than other financial instruments.
Suppose you are considering investing in digital assets but feel they are too volatile and therefore risky. In that case, you can simply adjust your exposure with an appropriate percentage to your portfolio, depending on the parameters outlined in this article.
The table below expresses how volatile Bitcoin is compared to the financial instruments we have listed in the table above:
Hence, in the long run, Bitcoin has proven to be 2.4 times more volatile than the US equity benchmark: the Standard and Poor’s 500. In the short run, as much as 10 times more volatile than the EUR/USD, the world’s most traded currency.
What are the opportunities Swissquote offers you in the world of crypto?
Find out on www.swissquote.com/crypto
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All investments carry a degree of risk.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74–89 % of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Digital Assets are unregulated in most countries and consumer protection rules may not apply. As highly volatile speculative investments, Digital Assets are not suitable for investors without a high risk tolerance. Make sure you understand each Digital Asset before you trade.
