The Impact of Cryptocurrency Volatility on Trading
- Discover the opportunities and challenges of cryptocurrency volatility in tradin
- Learn how to navigate it with Wirex's trading products
- Explore swing trading, recursive borrowing, and DUO
The rise of cryptocurrencies as a significant global asset class marks an exciting new phase in financial markets. Cryptocurrency market growth offers traders abundant opportunities to earn profits making informed trading decisions. Yet, it is not devoid of challenges, most notably with the primary characteristic of an emerging market, volatility.
In financial terms, 'volatility' refers to the degree of variation in an asset's price. For cryptocurrencies, these price swings can be quite pronounced, resulting in high risk, but also the potential for high returns. This guide seeks to help you navigate volatile market conditions by deepening your understanding of volatility and its impact on trading.
Understanding the Nature of Cryptocurrency Volatility
Since Satoshi Nakamoto invented Bitcoin in 2009, the cryptocurrency landscape has evolved dramatically, with the development of multiple liquid trading venues alongside liquid derivatives and futures markets. This evolution has fostered market stability for premium cryptocurrency assets like Bitcoin and Ethereum and has cultivated a strong worldwide interest in cryptocurrency trading and investing. Despite this progress, cryptocurrency assets still display significantly higher volatility than other traditional assets such as Gold (XAU) or the S&P 500.
Volatility in the cryptocurrency market stems from various factors. By their nature, cryptocurrencies are traditionally more speculative assets as they primarily reflect blockchain-oriented projects which, as of now, are not wholly integrated into the fundamentally pivotal global infrastructure. Consequently, cryptocurrency markets are significantly impacted by macroeconomic events, behaving similarly to speculative tech stocks during such occurrences.
Moreover, cryptocurrency tokens and projects are undergoing intense regulatory scrutiny as the world's most prominent regulatory bodies seek to establish a regulatory framework that encapsulates these assets. This scenario implies that cryptocurrency market volatility is heavily influenced by regulatory news events.
Finally, cryptocurrency volatility can be affected by many other factors including social media activity, social sentiment, large ‘whale’ transactions, market liquidity and overall global asset market health. A comprehensive understanding of these factors is crucial when considering trading in this volatile landscape.
Understanding Healthy Market Volatility
Volatility typically carries a negative connotation as it's often associated with market chaos, uncertainty, and loss. But it's crucial to understand that extreme volatility periods are relatively rare. More common is moderate or healthy volatility, characterised by price movements as investors respond to information flows such as broader macroeconomic sentiment.
In traditional markets, healthy volatility is defined as a value between 12 and 20 on the Volatility Index (VIX), also known as Wall Street’s “fear gauge." Though overall stock market volatility remains constant over the years, the extremities of VIX values have become sharper, leading to the perception of increased market volatility.
In comparison, cryptocurrency markets have volatility in a completely different league. Crypto market liquidity is far lower than traditional financial markets due to the lack of a robust ecosystem of institutional investors and large trading firms enhancing liquidity. As a result, the effects of news developments and speculation are amplified, resulting in greater price swings. However, with increasing participation from institutional investors and the emergence of a derivatives market, signs of a maturing cryptocurrency market with declining volatility are evident.
Mathematically, the 30-days historical volatility is measured as the standard deviation of the last 30 logarithmic daily returns. This indicator is now near a 2-year low.
The 30-days implied volatility is usually a better measure that can be determined from the price of derivative options: calls and puts that are expiring in 30 days. A call on BTC/USDT is an option to buy BTC for USDT at a predetermined level called ‘the strike’. When the call option expires, if the BTC/USDT price is above the strike, then the call option holder can exercise his option, and Buy BTC at the strike price that is lower than the market price. The higher the volatility, the more likely the BTC/USDT price can move above the strike level during the option’s life, boosting the call option premium. Using the observable price of the call, it is possible to derive the volatility level.
The block provides such an implied volatility level: the Bitcoin Volatility Index that is at 48.95 at the time of writing. This is 3 to 4 times higher than the 30-day implied volatility of the S&P500, given by the VIX index currently at 13.57.
Wirex Products to Trade Cryptocurrency Volatility
Wirex offers a suite of products that enable traders to navigate and potentially benefit from market volatility. These tools provide a range of strategies that can be tailored to suit individual trading objectives and risk appetites.
Swing Trading in the Wirex App
The swing trading strategy attempts to capture gains from the price changes of a cryptocurrency over several days to weeks. This strategy is particularly effective during periods of high market volatility, where these price swings can be significant. For example, using the Wirex app, you may observe that the price of Litecoin (LTC) typically follows a certain pattern of peaks and troughs. If you predict that LTC is at the low point in its cycle and likely to rise soon, you can buy LTC and aim to sell it when the price peaks, effectively capturing this price swing generated by market volatility. Of course, it is nearly impossible to target the lowest or the highest price point. If markets have a tendency to revert towards a medium or long-term moving average (MA), then regularly buying below the MA, and selling above the MA could yield more benefits if the market is volatile.. and healthy!
Recursive Borrowing with Wirex Multiply
Wirex Multiply allows traders to recursively borrow their trading, which can be a powerful tool during periods of high volatility. Recursive borrowing involves borrowing funds to amplify potential returns from a given price movement.
Consider a scenario where you predict that the price of Bitcoin (BTC) is about to rise. With initial funds of $1,000, you can use Wirex Multiply to open a recursive borrowing position with a 10x multiplier, giving you a position worth $10,000. If Bitcoin's price increases by 5%, your profit would be $500, a 50% return on your initial $1,000. It's crucial to remember that while recursive borrowing can increase potential profits, it can also amplify losses if the market moves against you.
DUO Positions with Wirex
DUO is a Wirex product that allows users to earn a pre-determined high yield of up to 400% APR, and potentially make a net profit when measured in the paid currency, if:
- the market remains within a specific range
- or if the open currency underperforms the second currency that has been selected by the user
DUO allows users to take advantage of periods of low volatility by generating returns in the form of an APR which exceed that of the price movements of the currency pair they invest in. This can be an excellent form of return generation during periods of low volatility in the cryptocurrency markets.
Consider a scenario where you predict that the price of the pair AAVE/USDT is going through a period of consolidation due to on-chain supply factors. To trade this relationship, you could invest in the AAVE/USDT yielding 200% APR (annualised) for 7 days. If your prediction comes true and the performance of AAVE against USDT is flat, you would retrieve the AAVE asset paid into the structure plus the APR payment, resulting in a net gain.
Cryptocurrency markets represent a new frontier in investing, presenting a unique mix of high risks and high potential rewards. The inherent volatility of cryptocurrencies can be daunting, and it indeed poses a substantial challenge for both new and seasoned traders. Understanding the drivers of this volatility, such as regulatory news, macroeconomic events, and market sentiment, is vital for formulating effective trading strategies.
Wirex offers a comprehensive range of tools and products to help traders harness the power of cryptocurrency volatility. From swing trading to recursive borrowing and dual positions, Wirex caters to diverse risk appetites and trading strategies.