Bitcoin and other alternative currencies have been some of the biggest disruptors in the financial sector today. They offer both high returns and high-risk potential. Another distinctive characteristic of these digital currencies could be their price instability.
Bitcoin is a cryptocurrency that users love to hate because of its wild swings on the market. For instance, Bitcoin, from its peak at approximately $65,000 per coin, traded at about $30,000 in mid-2021. But this is not limited to Bitcoin only.
If you look at the price prediction site Coindataflow for Arbitrium (a layer 2 scaling solution for Ethereum), the difference between the minimum and maximum price can vary from $5 to $10. This difference might not be as dramatic as in the case of Bitcoin, but it will still affect the investor’s portfolio.
This post explains the drivers of cryptocurrency price volatility. One of the best Strategies for managing cryptocurrency price volatility is to provide valuable insights to help you make decisions during the crypto market's challenging times.
Market volatility is the measurement of how the price of the asset changes over some time for a specific number of returns. Such movements could be extremely sharp in the case of cryptocurrency markets that operate at much faster rates than traditional markets when it comes to pricing. These high and rapid fluctuations of price in such a short period are a significant contributing factor to ease the investors wishing for a high return expectation. Still, on the other hand, it exposes more risks to them.
One fundamental difference between cryptocurrencies and stocks is that the market for the latter is traded according to set hours throughout the day. At the same time, the former is open for trading 24/7, seven days a week, across the world. This means that trading and price changes can occur now at random times of the day, and these changes are usually led by events that occur outside of market hours. Further, the current infancy stage of the crypto market and the minor market capitalization as compared to more established markets are some of the reasons responsible for the unpredictable nature of the crypto market.
Statistics that depict the volatility of the crypto market indicate that most markets experience high volatility. For instance, if one is trading in Bitcoin, then it is possible to witness massive movements in the price of this cryptocurrency in a single day, with prices changing by double digits. This kind of volatility is a double-edged sword: it can help investors amass a lot of profits but may also contribute to huge losses.
Cryptocurrency market fluctuate due to various factors, which have been found to be the leading causes of volatility in these digital assets. So, keeping a check on market fluctuation would be one of the strategies for managing cryptocurrency price volatility.
Sentiments are critical; it is the investors' perceptions that matter. Press release bulletins, tweets, and even gossip contribute significantly to the creation of short-term price movements as they affect investor perceptions. Good news can cause supply prices to rise, while bad news can cause supply prices to drop.
Cryptocurrencies exist in a qualitatively newer and still developing legal framework. News incorporating government regulation can lead to a significant fluctuation. For instance, when a country plans to introduce new regulatory policies, there is fear, uncertainty, and doubt from investors, which causes the prices to change.
News or new advancements in the blockchain area can also affect the price of cryptocurrencies. For instance, an upgrade in the security of a cryptocurrency network may increase the value of coins if investors are confident that it will improve the network. On the other hand, technical difficulties or security-related concerns may cause consumers to lose their confidence and thus drive prices down.
The crypto market is vulnerable to external pressure from large investors called “whales,” which hold significant amounts of a particular cryptocurrency. These entities have the power to manipulate the market by purchasing or selling in volumes that are enough to cause significant price changes and, in turn, profits; this practice, however, causes considerable market instability for the other traders.
Thus, fluctuations in cryptocurrency prices are not only influenced by internal factors connected with the functioning of the cryptocurrency market but also associated with broader economic conditions. These external influences can have profound effects on the cryptocurrency market:
Economic factors such as inflation rates, economic growth rates, and commodity price fluctuations also affect investors across all markets, including the crypto market. For instance, if the inflation rate is high, investors may start to look for other assets to preserve their wealth, like Bitcoin, which they consider an inflation hedge.
Fluctuations in the market price of cryptocurrencies are often associated with political instability, economic sanctions, and significant decisions by country governments. For example, if a big economy announces Bitcoin as a legal tender or when some country outlaws the use of cryptocurrencies, the prices of Bitcoin will go up or down, respectively.
Fluctuations in the value of major fiat currencies in relation to cryptocurrencies can also impact crypto prices. If the dollar becomes weaker by devaluation, then the value of cryptocurrencies denominated in USD may increase the appeal for foreign investors as well as prices.
Investor behavior has a massive effect on the cryptocurrency market and can be held responsible for its enormous volatility.
The cryptocurrency market has two categories of investors – retail and institutional investors. Individual investors exhibit higher levels of responsiveness to information and changes in prices on the stock market. While individual investors are known for their highly speculative trading activities which have short term outcomes on market prices, institutional investors are characterized by more controlled trading with larger blocks of stocks that have long-term impacts on market prices.
The psychological effects that manifest in the market like FOMO or panic selling result in huge price fluctuations. They may lead to other investors’ emotions like price trends, news events, or market rumors, which encourage volatility.
The measure of this liquidity – how easily assets can be bought and sold without impacting the price – also plays an essential role. Higher volatility suggests that lower liquidity can generate higher price changes even for insignificant trading volumes.
Given the inherent volatility in the cryptocurrency market, investors need effective strategies for managing cryptocurrency price volatility to manage risk and capitalize on potential opportunities:
Diversification: Diversification is a powerful strategy, but it is also important not to rely on just one thing. For instance, you can reduce risk by investing in multiple currencies and other assets, including stocks and ETFs. Diversification entails holding several assets in an investment portfolio, if one asset turns out to be a loser then the other assets may turn out to be winners hence reducing the impact of losses in case one asset turns out to have negative returns.
Risk Management Techniques: Secondly, they should employ stop-loss orders and limit orders to secure their investments. These tools can be utilized to set up orders at certain prices for the trading to be automatically triggered and prevent large losses during panic sell-offs.
Long-Term Perspective: On the other hand, you may want to take a long-term investment strategy. Investing in such crypto with a long-term perspective and a solid foundation might provide additional stability during price fluctuations.
Emotional Discipline: Do not make decisions on quick glimpses of the market trends. Never at any one time let fear or greed influence your decision on what to invest your money in; rather strictly follow your investment strategy or plan and deviate from it only as when you deem \necessary following an in depth analysis of the situation.
Now you realize what causes such waves and how to deploy effective practices in such investments to harness the crypto economy’s benefits.
This is why cryptocurrencies' price volatility cannot be controlled with one single method, only with effort, rationality, and information. These insights can help investors identify strategies for managing cryptocurrency price volatility and increase the likelihood of successfully navigating the risky crypto market.
However, no strategy can guarantee a complete zero-risk investment, and, therefore, one must invest money only if it can be risked. As the market becomes increasingly saturated and institutional investors start to play their role, the level of volatility may go down. For now, it is reasonable to say that risk management is the most effective strategy for investing in cryptocurrency.
What factors contribute to cryptocurrency price volatility?
Several factors, such as trading volume, information demand, stock returns, exchange rates, Google trends, total Bitcoin circulation, US consumer confidence, and uncertainties surrounding economic policy, all have an impact on the volatility of cryptocurrency prices. Key elements influencing commodity price volatility include supply and demand, the state of the economy, the climate, geopolitics, and financial speculators. These factors can also have an impact on cryptocurrency markets.
How can I mitigate the risks associated with cryptocurrency price volatility?
To reduce the dangers associated with cryptocurrency prices' volatility, consider diversifying your portfolio, using stop-loss orders, and using risk management techniques like Bollinger Bands and Average True Range. Setting reasonable objectives, getting expert guidance, and carrying out in-depth research can all help improve risk management when making cryptocurrency investments.
How do stop-loss orders work, and how can they help manage cryptocurrency price fluctuations?
Stop-loss orders assist in controlling cryptocurrency price volatility by offering a defined exit point in erratic markets. They automatically sell assets at a set price to limit losses.
What role does diversification play in managing cryptocurrency price volatility?
Spreading assets across multiple cryptocurrencies and asset classes can help limit risk by minimizing the impact of price swings in any one asset. This is why diversification is essential for managing cryptocurrency prices' volatility. Setting reasonable objectives, getting expert guidance, and carrying out in-depth research can all help improve risk management when making cryptocurrency investments.
Is hedging a viable strategy for mitigating cryptocurrency price risks, and how does it work?
Hedging is a workable method for reducing the risks associated with the price of cryptocurrencies by adopting opposing positions to lessen exposure to unfavorable price movements. Using stop-loss orders, spreading your assets among different cryptocurrencies and asset classes, and locking in prices with derivatives like futures contracts are all examples of common hedging strategies.
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Disclaimer: Analytics Insight does not provide financial advice or guidance. Also note that the cryptocurrencies mentioned/listed on the website could potentially be scams, i.e. designed to induce you to invest financial resources that may be lost forever and not be recoverable once investments are made. You are responsible for conducting your own research (DYOR) before making any investments. Read more here.