Cryptocurrencies are considered (one of) the highest-risk investments you can make. This risk is reflected in the volatility of their value. Volatility is nothing more than a measure of variation of price over time. In other words, it’s a measure of how wide the swings of a cryptocurrency’s price can be. These movements can be downward as well as upward, so volatility doesn’t provide any insights into directions. Volatility can be derived from a series of historical prices, which is known as historical volatility or statistical volatility. The higher the volatility, the more movement the concerned cryptocurrency has experienced. Therefore, theoretically, it could also move more in the future.
To better understand volatility, let’s consider the following example from investopedia: “It [Volatility] can be calculated simply by taking the past prices, in this example 10 days are used, and price changes (from close to close), and then taking an average of those price changes in percentage terms. Once we have an average percentage price change over 10 days, we can subtract the daily percentage price changes from this average change to derive deviations from the daily average change for the 10-day period.”
The fastest way to compute the volatility, or standard deviation, from the daily price changes in this example would be to simply use the STDEV function in an Excel spreadsheet. Because standard deviation is a statistical measure, it means that prices will end up within one standard deviation of their original value 68 percent of the time. If the 1-day volatility (one standard deviation) is equal to for example 10 percent it would imply that on 68 out 100 days the price movement will be within the 10 percent. On the remaining 32 days the price movement is expected to be more than 10 percent.
There are still significant differences between cryptocurrencies. Unfortunately, exact numbers aren’t often provided. To get a glimpse of how risky cryptocurrencies exactly are, and how they differ, a sample of 508 hourly observations were collected from Cryptsy. To get reliable data, only the price changes of cryptocurrencies with an average hourly volume of $13,000 were taken into account. This leads to the following summarized results:
The table reveals that Bitcoin is the least risky cryptocurrency with an hourly volatility of almost one percent. This is very high, and would imply a daily volatility of around five percent as volatility scales with the square root of time. But as shown by Auroracoin (AUR), hourly volatility can even be as high as 7-8 percent.
High volatility means additional risk if you decide to trade during these times, as market conditions can affect your trade. If you manage to successfully trade, higher volatility means you’ll gain or lose value quicker. For the average consumer or business, high volatility is one of the main reasons to stay away from cryptocurrencies.