What is volatility?

Volatility is a measure of how much the price of any given asset has increased or decreased over time. In general, the more volatile an asset is, the higher its investment risk, and the more likely it is to achieve higher returns or suffer greater losses in the short term than assets with relatively less volatility.

As a new asset class, cryptocurrencies are generally considered to be highly volatile, and their prices may rise or fall significantly in the short term. Stocks are also considered to be highly volatile, with large-cap stocks (such as those of Apple or Berkshire Hathaway) relatively solid, while \"low-priced stocks\" often fluctuate violently. In contrast, bonds are considered less volatile assets, and their prices usually do not rise or fall sharply, but show a smoother trend over a longer period of time.

How to measure volatility?

When it comes to a measure of volatility, people usually refer to \"historical volatility,\" which is a value based on price data over a specific period of time, typically 30 days or a year. Forecasting about the future direction of the market is called \"implied volatility\" and since no one can predict the future with certainty, it is not an exact science, although it is the basis of widely used financial instruments such as the Cboe Volatility Index (known as the \"panic index\" and used to predict stock market volatility over the next 30 days). You can quantify volatility by:

1. Use the Beta coefficient as a tool to measure the volatility of a single stock relative to the entire market (usually based on the Standard & Poor\'s 500 Index).

2. Calculate the standard deviation of the asset to measure the degree to which the asset price deviates from its historical average.

Why is it important to understand volatility?

Volatility is an important indicator of investment risk. In general, investors are willing to take on high risks because they believe the potential return is worth losing part of the investment. (Or invest all, as in the recent case of high-risk hedge fund manager Bill Hwang, whose fund lost $20 billion in two days.)

Retail investors have historically been advised to diversify their investments within asset classes to reduce risk. One of the most common strategies is to invest in a basket of stocks (or index funds) rather than just a few stocks. To further reduce downside risks, they can also match volatile asset classes such as stocks with less volatile asset classes such as bonds.

As an asset class that has only been in existence for more than a decade, cryptocurrencies have experienced many ups and downs and are considered to be more volatile than stocks. Still, as trading volume in Bitcoin (currently the largest cryptocurrency by market value) increases and institutional participation increases, its volatility appears to be gradually decreasing. However, cryptocurrency or emerging cryptocurrency assets with low trading volumes (such as DeFi tokens) tend to have high volatility, and novices should be cautious when trying to invest in these assets to ensure that the funds invested are something they can afford to lose.

Factors contributing to higher volatility include positive or negative news reports, earnings reports that are above or below expectations, etc. Abnormal surges in trading volume are often accompanied by increased volatility. Extremely low trading volumes (such as low-priced stocks that are not traded in major markets or cryptocurrencies with small market capitalizations) often also mean high volatility.

Are there any ways to reduce the volatility of cryptocurrencies?

For some cryptocurrency investors, high volatility is part of its appeal, as it means the opportunity to earn high returns. (Although Bitcoin\'s volatility seems to be declining, its volatility still often reaches double digits during the week, so strategies such as \"buy on dips\" can be used.)

Investors with low risk tolerance can use strategies such as the average cost approach to mitigate the negative impact of volatility. (Generally speaking, investors who adopt long-term strategies do not need to think too much about short-term fluctuations if they are convinced that their investment will eventually increase in value over time.) Currently, there are also cryptocurrencies on the market that aim to reduce price volatility and achieve low volatility. They are called stablecoins (such as USD Coin and Dai), and their prices are pegged to reserve assets such as the US dollar.