Importance of Volatility and Liquidity in Cryptocurrency Trading

Tradability is not just about price. Something can be extremely valuable in price, but if it is not volatile, it presents no opportunity to trade. If it is too volatile, it presents reduced security to trade. So a balance must exist in the level of volatility and the liquidity of the market. The best way to trade a coin is if there is sufficient liquidity and heavy volatility. 

Why? Because volatility could happen because of the lack of liquidity. In this event, if you entered the market and traded the coin, you may not be able to get back out. And the trade may be a floating profit for a moment but turn to a loss by the time you find a counterparty to execute the transaction. 

In the case of liquidity, the more popular and the higher the user base is, the more liquid the market and the lesser chance there is for the currency to have wild price gyrations due to momentary purchases and sales. This is one of the reasons Bitcoin is more expensive than other altcoins─because it provides better liquidity. This liquidity premium prices in the effect of immediate entry and immediate exit so that the price reflected on your trading screen is very close to the price you get when you execute a trade.

Liquidity

There is no doubt that there is a rush to create the next bitcoin or to surpass it. There have been millions, even hundreds of millions invested by old-currency investors to be able to dominate the future of cryptocurrency. And as a result, you get figments of bits and bytes that can rack up values of over $5000, like Monero soon after its launch. There is a specific kind of risk profile attached to each cryptocurrency and that risk profile is a function of its liquidity. 

The liquidity of an asset determines its overall value, price, strength, and most of all, the belief fans and followers have in a particular asset. Look at gold as an example. It is merely metal and has some properties that are interesting, but it is just another item on the periodic table. It is the allure human beings attach to it that makes it valuable. The same goes for the value of cryptocurrencies. It is the value that humans place on it by their actions. The more they buy it, the more they trade it─and the more they use it as part of their transaction, the more it becomes the de facto currency.

To be good at the cryptocurrency, you have to understand its popularity, and many of the factors that lead to it need to be internalized by the close study. The best traders instinctively understand the way the currencies work and how they respond to an event on the market. 

How then to choose currencies to trade? Whether it is purely cryptocurrency─which means it’s one cryptocurrency for another and vice versa, or it is from fiat to a cryptocurrency─the thing you have to do to pick the currency with the most profitable pairing. That’s the one that gives you the ability to ride the transactions effectively. There is a benefit to working with volatile coins if you are able to find the necessary liquidity to enter and exit the market. Liquidity is your most important factor. 

But what about liquidity in coins that have not been established for long? Look at BTC vs Monero. The value of BTC still outweighs the newbie, but that still allows for a trading strategy. So in this case what you have is a holding of BTC as the core, and parts of it are used to buy into Monero. That way you benefit from the security of the older coin, and the potential appreciation of the young coin. This is a strong strategy and you should use it in part of your trading endeavors.

Volatility 

In parallel with volatility, you have liquidity. This is a harder measure of a currency’s investability. A volatile currency is a function of a number of factors. There are currencies that are inherently volatile because of a number of their underlying features. Then there are assets that are volatile because they do not have many owners or buyers and sellers, so that whenever someone wants to make a purchase and the come out the of the market the place a sell order and it becomes a buyer’s market. 

A buyer’s market means that the buyer can wait out the seller till he lowers the offer because he is in a rush to liquidate his asset. Or it could be the other way around. When the buyer comes to the market and wants to buy, he has to raise the price behind what the last trade made so that the seller is enticed to come to market and part with his lot. This creates an artificial pricing scenario, but really it is the premium for the seller to sell when he was not planning to, or the buyer to buy when he was not planning to. The price difference between the buyer and the seller gets further apart the thinner the market gets. When the market thins out, any trade is going to be largely different from the trade before. With a thin market, it resembles more of an individual seller or an individual buyer and loses all form of predictability. And with that, the pricing gets skewed. 

When you choose a currency, you want to make that the currency needs to have a sound level of liquidity so that the volatility is not severe. The thing about volatile markets being like they are because of low volumes is that it tends to mess with the auto-trading systems and the indicators for buy and sell points. The bottom line that these metrics use is that there is always a buyer and a seller available so that the pricing is as fluid as possible.

Stay away from illiquid markets unless you are in it for the long-term gain of doing something strategic with the currency. If you have the appetite and the ability to hold or lose all your investment, then it is a good strategy as long as you have the right goal. But if you are just a trader looking for a return on investment, stay away from illiquid markets.

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