A number of indicators can be used to measure volatility levels in traditional trading markets. But what about cryptocurrencies? Can comparables be found, and if so, how can they be applied to trading for better outcomes?
As traditional assets (e.g. stocks) are far older and more widely-established than cryptocurrencies, traders already have a good range of volatility-measuring methods to choose from. Examples include Bollinger Bands, Average True Range, and CBOE Volatility Index. But can we apply these to cryptocurrency trading too?
ATR (Average True Range)
Average True Range was created in the 1970s, by a market technician known as J. Welles Wilder Jr. This technical analysis indicator is fairly straightforward, since it grows with rising fluctuation levels: a higher volatility level has a higher Average True Range level.
Other indicators may be used alongside this to create a cohesive strategy. For instance, day traders may find it helpful to use the entire range of indicators for volume, momentum, and trend (MFI, RSI, SMA). But Average True Range is unable to confirm a starting rally for a brand-new trend and it can’t inform you of which direction a crypto price is expected to move with certainty. It can only signal peaks in volatility.
Bollinger Bands is more than a volatility indicator, as it can identify trends and detect overbought/oversold market conditions too. We’re focusing on its function as a volatility indicator for crypto traders here, though.
With Bollinger Bands, multiple bands appear on your screen. The one in the middle represents an exponential moving average. The upper and lower bands plot the negative and positive deviations in price from the asset’s average price. So, traders monitoring the bands’ range can track volatility levels across a specific period of time.
What other Crypto Volatility Metrics can I use?
Bitcoin Historical Volatility Index
We mentioned the CBOE Volatility Index further up the page, and we’ll explore it below. Yet what of alternative metrics employed for traditional trading? Such as option pricing models and standard deviations of returns?
As the cryptocurrency market could still be considered in its infancy, all of these metrics may not be applied to it effectively. An asset’s specifics don’t typically allow traders to take advantage of identical tools.
So, what about the CBOE Volatility Index? This was created by the Chicago Board Options Exchange (CBOE), and is calculated with the S&P 500® Index (SPX) option bid/ask quotes. As a result, it’s unsuitable for use when trading cryptocurrencies. But the Bitcoin Historical Volatility Index is a fantastic alternative.
A beta coefficient enables traders to compare their asset’s volatility against that of the entire market, or that of another benchmark (depending on the user’s approach).
Multiple formulas may be used to calculate beta. Essentially, a resulting value exceeding 1 shows that an asset is volatile and has high market correlation. But if the value is lower than this, that could signal that the asset’s volatility is lower than the relevant benchmark.
As an example, you could measure the volatility of Bitcoin against stock markets, and Litecoin’s against Bitcoin.
So, not all of the methods for measuring volatility levels cross from the world of traditional trading to cryptocurrencies successfully. But let’s cover those which do one more time.
Average True Range is an indicator which grows as market level fluctuations increase, so that a higher volatility level leads to a higher ATR level (and vice versa).
Bollinger Bands enable you to determine volatility levels just by monitoring how regularly price tags drop into lower and upper bands across a given time frame.
Finally, crypto traders can leverage the beta coefficient and Bitcoin Historical Volatility Index too.