Investors and traders, especially those of us who are still on the learning curve (do we ever stop learning?) often confuse notions of volatility and risk.  The usual thinking is that if something is highly volatile (think Tesla stock, or Bitcoin), it is also highly risky.

That’s not entirely true.  It’s very possible that something could be both volatile and risky, but the point I want to make here is that just because something is highly volatile doesn’t make it highly risky (unless you don’t know what you are doing).

High volatility is characterised by large swings up and down on the price chart.  It can certainly lead to a few empty bottles of Pepto Bismol, but, and this is particularly true of the cryptocurrency market right now, you can’t have huge gains (and losses) without huge volatility.

If you are an investor, your strategy is more than likely to buy in at a price you are confident will be lower than the target price at the end of the period you are holding the coin/stock for.  This is the way HODLers (Hold On for Dear Life) invest.  They see the price of Bitcoin in 4 years at close to $500,000 and so they buy in at $35,000 or $50,000 and settle in for the ride.  They will largely ignore the volatility in the coming months and years with their eyes firmly fixed on the prize.

Traders, or shorter term investors will need to consider volatility much more closely.  If you are trading, your gains are made entirely on the ups and downs of turbulent charts.  The more volatility the better.  

But isn’t the probability of huge dumps in a stock or a coin risky?  Yes.  But risk can (and should) be managed. Proper risk management is a huge part of trading and investing.  Using risk management we can minimize the downside while reaping all of the benefits of the upside.

I will offer a couple of examples from my own experiences this year to illustrate what I’m talking about. I built most of my major crypto positions in January (2021).  My plan was (and mostly still is) to hold these until the end of the cycle towards the end of this year and sell all but 20% at or near the top, then wait until it bottoms out and start buying in again.  It’s a good plan, but as I learned more about the crypto markets and trading in general, I began to notice that I was leaving a LOT of potential gains on the table.  My current thoughts are that if I sat on long positions during the bull run getting amazing gains, it would be logical to ride short positions down to the bottom.  I’m looking into that now and beginning to prepare.  I see that as using both sides of volatility to increase my gains.

I was told when I got into crypto that: “In stocks if the price goes down 35% people are jumping out the windows; in crypto it’s a Tuesday”. So in May when the market started to tank, I did as any good HODLer would do and hunkered down to wait it out because I was convinced that the cycle wasn’t over.

I won’t lie; it was stomach churning. Every massive red candle made me feel physically nauseous, but I rode it out and that perseverance is being rewarded now as the market has completely recovered and is poised to venture into new all time highs.

Looking back though, I think I made a huge mistake.  If I had set stop losses and got kicked out near the highs of $65K in Bitcoin, I could have used the profits to buy even more at half the price when it bottomed out at $28K.  Lesson learned.  Once BTC hits 75 or 80K  I will add trailing stops, low enough not to get stopped out due to ‘normal’ volatility, but enough that I can take advantage of another huge May event should it occur.

The goal in my own trading journey is to be able to make better use of volatility.  I still allocate a certain amount of my crypto to hold as a long term (collateralizable) asset, but I am now allocating an amount to a trading account where I am honing my trading skills and better using the gift of crypto’s awesome volatility. 

 

My next and final example is about my trading activity.  ByBit, the trading platform I use, trades on leverage.  THAT is risky!  But I spent a lot of time before jumping in to that kind of trading getting my trading rules in place.  Almost all of those rules are in place to manage and minimise the risk.

Here’s something to think about: one of my rules is that I never risk more than 5% of my total capital on any one trade.  So if I have $100,000 capital in my trading account (which I don’t but math and I aren’t the closest of friends so let’s make it easy),  you might think that the largest trade I could make is $5000, but that’s actually not correct.

What is my risk on a $5000 trade?   If I don’t use a stop loss, you could argue that my risk is the full $5000 and I would agree.   But let’s look closer.  If you are trading with leverage and no stops you are actually risking the whole $100 000.  Why?  Because if the price drops below the liquidation price your whole account gets cleaned out. That’s where the term ‘rekt’ comes from.

Well that’s crazy!!  Who would do that, you might wonder.

Using stop losses changes that equation.  If I put down $5000 on a trade and add a 5% stop loss(always above the liquidation price), what is my risk?  My risk on the trade is actually only $250.

So, theoretically,  if my trading rules state that I can’t risk any more than 5% on a single trade, I can (again, theoretically) put down the whole $100 000 on that one trade and if I add a 5% stop loss, I am risking only $5000.

Because of this, if you use proper risk management, leverage trading isn’t quite as crazy risky as it initially sounds.  I will say that I definitely checked this out in practice before I started laying down significant amounts in my trades.  I wanted to make sure that a massive sudden drop wouldn’t bypass my stop loss and instead trigger a liquidation.  I can attest to being immediately kicked out of a trade the instant a wick or a candle touches my stop loss. 

So the learning curve continues.

If you are interested in learning more about how to work with volatility (and make it your friend), you might want to take a look at the Average True Range (ATR) indicator to use on your charts. 

It’s very powerful.

In summary, when thinking about volatility vs. risk; they are not the same. Volatility is something that you want to see in an equity or crypto that you are trading, risk is something that you can manage.