The study of volatility has grown over the recent years. But what is it really? This short entry will try to explain what 'volatility' means and how it can be applied to all financial assets, including cryptocurrencies.
Price volatility essentially refers to movement in the underlying away from an average level. Without getting into the math, this might be best demonstrated with an example. Say for example the price of your favorite cryptocurrency trades at a high of $15 and a low of $10 in one day. The difference between the high and the low is $5. On the following day, the high is $18 and the low is $8. This is a difference of $10. The range between the highs and the lows is increasing, and so therefore we could say that volatility is increasing. The reverse would be true if on the following day it had a high of $15 and a low of $14. The difference would only be $1 and therefore volatility is decreasing.
Higher volatility equals more price movement away from its average level.
The same concept can be applied to all financial assets or cryptocurrencies. And as a general rule, if prices stay around the same level for long periods of time, then one could assess that volatility is low. Why is volatility so closely monitored and important? Because volatility equates to price movement. Higher volatility equals more price movement away from its average level. If volatility could be forecasted or estimated for the following day or week, then it would also be possible to construct price ranges that will likely contain all prices over that time period (day or week). This allows for control of risk and position sizing for more risk averse investors.