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Crypto market volatility is often thought to be on a scale of its own, with Bitcoin (BTC) and other cryptocurrencies often going through head-spinning price rollercoasters. Over the past few years, the world's leading cryptocurrency Bitcoin has experienced crazy price swings. After beginning to recover from a disastrous November 2021 crash, Bitcoin plunged into a multi-month steep decline in March 2022, losing nearly two-thirds of its value between late March and early November.
Crypto market volatility is often thought to be on a scale of its own, with Bitcoin (BTC) and other cryptocurrencies often going through head-spinning price rollercoasters. Over the past few years, the world's leading cryptocurrency Bitcoin has experienced crazy price swings. After beginning to recover from a disastrous November 2021 crash, Bitcoin plunged into a multi-month steep decline in March 2022, losing nearly two-thirds of its value between late March and early November.
Investors have once again witnessed Bitcoin's well-known volatility in recent times. From the beginning of October 2023 to the end of March 2024, the cryptocurrency increased by 174%, which seems almost unreal to a stock market investor. However, in September of this year, Bitcoin lost almost 21% of its March 2024 value and continues to exhibit significant volatility.
So, what is it about volatility that tends to impact both Bitcoin and the wider crypto market and what strategies can be put in place by investors to try and mitigate against them. Throughout this post, we have elaborated on how market prices can be volatile in the digital currency sphere and how to leverage it.
Volatility refers to the rate of change of value over time for a financial asset. High price volatility of assets is characterized by frequent price fluctuations. Volatile assets are considered very risky from an investment point of view. However, investors in any market know that higher risk levels mean higher return opportunities. Indeed, in financial markets, volatility and risk are synonymous.
Volatility is usually measured using the coefficient of variation, which shows the general level of change in an asset over a period of time. Usually, this volatility is expressed as a percentage.
In general, the volatility of cryptocurrencies is significantly higher than that of stock markets, often exceeding the volatility found in commodity markets. Even Bitcoin, which is seen as less volatile than smaller altcoins, still exhibits much higher volatility than traditional financial assets. Although the one year volatility for Bitcoin may be less than that of an index fund, they are still nearly at 40% by April 2024 as shown in the chart below. In contrast, gold and world equities (ACWI IMI) had a one-year annualised handled volatility of 10% while the US Agg had produced the smallest at 2.5%, which is open to trade twice on day for schedule circulations over last year through April 2024.
There are a few key reasons that make the crypto market way more volatile than the traditional market and they will be covered:
Maintaining positive market sentiment is crucial in all trading environments, but its impact is particularly profound when it comes to cryptocurrencies — due largely to the lower barriers compared with stock markets. There are also many Decentralised Finance (DeFi) platforms along with a few Central Exchanges (CEXs) that will enable you to invest your money without having a lot of it, and many times little to no identification. Consequently, many retail investors try to take advantage of this access which, again given the spread of their experience base tends towards less comprehensive technical or fundamental analysis. As a result, they tend to invest with the feeling of the moment or prevailing in discussions on social networks andonline newspapers.
As crypto investors are largely young, they tend to use social media as a way of characterizing the overall sentiment in the various crypt assets. Meme assets suchjson as Bitcoin and Dogecoin (DOGE) have been known to shift sentiment through the whims of influencers like Elon Musk.
From the moment of appearance in 2010–2011, crypto markets are still very young — 10 to 14 years old at most. Stock trading, on the other hand, has existed for thousands of years; similarly so as commodity markets.The crypto market's immaturity implies that its key characteristics and rules are still being formulated.
Compared to traditional markets, the crypto landscape is less regulated, although this scenario is slowly changing. Following the FTX exchange collapse, regulators in the U.S. and globally have struck out trying to write laws that will govern better cryptocurrency trading and investment. In 2023, the U.S. Securities and Exchange Commission (SEC) defined many cryptocurrencies as securities which opens a door for controlling this type of assets by the regulator. There are now some Bitcoin Spot ETFs launching in early 2024 after the approval of 11 approved ETFs, and analysts think this would help stabilize crypto prices as more main-stream investors get involved with Bitcoin. Generally, the crypto market remains much less regulated than stock markets, contributing to its well-known volatility.
Broader economic indicators, such as inflation rates, interest rates set by central banks, GDP growth, and significant trade agreements, can significantly influence crypto market volatility. Institutional investors frequently adjust their investment allocations across asset classes based on data and forecasts.Their decisions may involve moving funds, between cryptocurrencies and traditional assets such a bonds stocks or commodities.Due to the liquidity, in the cryptocurrency market such adjustments can have significant consequences.
In contrast, to markets where trading halts occur periodically the market functions non stop throughout the day and night which contributes to its heightened unpredictability.
Certain types of orders and methods can help reduce the risks linked to trading cryptocurrencies significantly. These tactics encompass stop loss orders, take profit orders position sizing and leveraging put options.
When you place a stop loss order while trading assets, like stocks or cryptocurrencies and the price hits a predetermined level called the stop price; you automatically. Sell to limit losses in the unpredictable world of crypto trading.
Traders are advised to close a position when it hits a profit target with take profit orders;, unlike stop loss orders that're for minimizing losses take profit orders are, for locking in profits instead.
Determining the amount of units assigned to a trade is what position sizing entails; this decision is made considering the traders portfolio and risk tolerance level in mind. During periods of market volatility practicing cautious position sizing can serve as a safeguard, against losses stemming from an excessive reliance, on one asset or position.
A put option is a contract that grants the right to sell an asset at a specific price within a designated timeframe. These options can serve as a safeguard against price declines in a bear market characterized by high volatility.
An additional effective approach to managing volatility involves portfolio diversification (this is crucial). By allocating your investments among various asset classes or cryptocurrencies that exhibit minimal correlation with one another, you can reduce the risks associated with unfavorable price fluctuations. For instance, although Bitcoin may display limited correlation with the stock market—particularly with non-tech stocks—under certain market conditions, balancing your portfolio becomes essential. By incorporating both Bitcoin and diverse non-tech stocks, you may (however) realize gains from the latter during periods when Bitcoin incurs losses, because this strategy helps mitigate overall risk exposure.
Hedging (as a strategy) is widely recognized for its potential to reduce investment risks; however, it often requires careful consideration. Typically, this approach involves taking offsetting positions to shield oneself from unfavorable price movements. Although put options are frequently mentioned, they represent just one method to manage volatility in the crypto market. For instance, one common hedging tactic is to purchase a put option on an asset you are holding long. Conversely, a trader might opt to buy a call option on an asset they are shorting because this can provide a counterbalance to potential losses. Yet, the effectiveness of these strategies can vary significantly based on market conditions (and other factors).
Regulating one's emotions during trading is essential; this is particularly true in the volatile realm of cryptocurrencies. Sentiment, after all (because it drives a significant portion of trading activity), plays a pivotal role. Therefore, a pragmatic approach to mitigate emotional involvement involves closely observing the prevailing market sentiment. Tools such as crypto sentiment indices can effectively measure degrees of fear (often linked to selling pressure) and greed (often associated with buying interest) that affect market dynamics. One notable example is the Crypto Fear & Greed Index, which is accessible on Alternative.me; however, traders should use it judiciously. Although these indicators provide valuable insights, reliance solely on them might not suffice for success in trading.
Beyond utilizing sentiment measurements, grounding your decisions in extensive research on the cryptocurrencies you are interested in will guard against emotional trading. This research should cover essential aspects, including the team's credibility behind a project, coin distribution strategies, actual platform activities, roadmaps, whitepapers, venture capital raised, and historical price trends.
All trading volumes related to crypto assets are reviewed for volume analysis, such as last 24 hours, 7 days or more etc. Analysts frequently assert that volume spikes can foreshadow price increases, while declines in volume might precede price drops.
Moving averages serve as useful visual aids in analyzing crypto asset volatility. A simple moving average is calculated by averaging a set number of recent price points (like daily closing prices) over time. The averages are subsequently plotted in conjunction with the main price line on a chart. Typical intervals for averaging may include (but are not limited to) 5, 10, 20, 50, or 200 periods. However, this can vary depending on the preferences of the analyst. The resulting moving average lines are generally smoother than the actual price lines, which aids in identifying potential trend reversals (because they filter out some of the market noise).
Bollinger Bands serve as a valuable visual instrument for assessing trends and momentum within a given asset (1). A typical Bollinger Band chart comprises three distinct lines: a 20-day moving average price line, an upper line positioned at two standard deviations above this average line and a lower line situated at two standard deviations below. The periods for the moving average can be adjusted (2) and the number of standard deviations employed can also be tailored, because user preferences often vary. However, it's important to note that this customization allows for a more nuanced analysis, although it may require a deeper understanding of statistical principles.
The Average True Range (ATR) represents a 14-day moving average of true ranges for a particular asset; each true range value indicates the most significant difference (or deviation) between the most recent high and low prices. ATR is considered a useful tool for evaluating an asset’s price volatility. However, its effectiveness can vary depending on market conditions. Although it provides insight into potential price movements, traders should use it in conjunction with other indicators because no single measure can capture the full picture. This underscores the importance of a comprehensive analysis in trading strategies.
Fibonacci retracement serves a crucial role in assessing price volatility and identifying both support and resistance levels. To effectively employ this tool, one must first pinpoint two price extremes—a swing high and a swing low—on the price chart. Following this, a range of price points (which represent horizontal levels) are calculated and plotted within the identified range. These levels typically correspond to percentages such as 23.6%, 38.2%, 50%, 61.8% and 78.6% of that range; each of these percentages is derived from Fibonacci sequences observed in nature. When the price of an asset makes contact with these Fibonacci levels, it indicates to traders the possibility of reversals, consolidations, or breakouts. However, the interpretation of these signals is not always straightforward, because market dynamics can vary greatly. This complexity means that traders must approach these indicators with caution, although they can provide valuable insights.
The Relative Strength Index (RSI) serves as an important technical indicator, helping to confirm whether an asset is overbought or oversold. This indicator ranges from 0 to 100: values above 70 generally indicate an overbought condition, while those falling below 30 indicate an oversold condition.
However, the volatility that exists in the cryptocurrency market poses significant challenges, but it also offers unique opportunities for investors willing to navigate these high-risk, high-reward landscapes. Although the crypto market remains in its infancy, its loose regulatory framework, coupled with constant trading and a heightened responsiveness to sentiment-driven fluctuations, is likely to continue to shape trading dynamics. For this reason, it is essential for traders and investors to perfectly manage this volatility using a variety of strategies, indicators and order types, as discussed earlier.
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