Measuring Volatility

Returning to bitcoin as our example, the amount by which its price goes up and down is measured by Volatility. Volatility is what determines the level of risk you take on in trying to make a successful trade. 

If you look at a daily bitcoin chart by eye, you’ll see peaks and troughs that look a bit like a seismograph, which is a useful analogy. Each movement is a reaction to the intensity of buyers and sellers, in the way a seismograph illustrates the intensity of tectonic activity. 

The literal definition of price volatility is the standard deviation of daily % changes. In simple terms, how much does the price deviate each day from the average.

Though it is important to understand how to calculate Bitcoin Volatility, measures are freely available online, here’s one example for 2020. The majority of the year the Volatility Index was somewhere between 2 and 4%, but with a huge spike in March/April, as it hit over 10%.

Returning to our earthquake analogy, this is like a 9 on the Richter scale, a major event. This was the reaction to the impact of Covid19 on the broader financial markets.

A Volatility Index of over 10% literally means theoretical returns of that size for daily trades within that period. For comparison, the volatility of gold averages around 1.2%, while other major currencies average between 0.5% and 1.0%.

The Volatility can be even greater when looking at an even shorter time frame, as it is simply an average, which means that on certain days the risks of trading are very high. 

The seismic event of Covid19 is virtually impossible to predict, but these kinds of market shocks must be expected. If you decide to trade regularly then there will be days when you are likely to experience significant swings in both directions.

As volatility works by looking at the variance in average bitcoin price, charts enable you to automatically plot what are known as moving averages, for standard periods, and overlay the spot price. 

Moving averages are one of the first indicators available within the technical analysis toolkit. They essentially allow you to view today’s price in a wider context. The longer moving average timeframe the more valuable the conclusion.