Portfolio Insights: Volatility and Its Importance in Digital Asset Investment Decisions with Trac ALPHA

Investing in digital assets offers exciting opportunities for growth, but it also comes with inherent risks. One of the key metrics for assessing the risk of an investment is volatility. In this Portfolio Insights Series, we will explore what volatility is, why it's important, how to calculate it, and how TRAC Alpha can help you make decisions to manage and optimise your institution’s investment portfolio.

What is Volatility?

Volatility measures the degree of variation in the price of a financial asset over time. It indicates how much the price of an asset can fluctuate within a given period. High volatility means the asset's price can change dramatically in a short time, while low volatility indicates more stable price movements.

Understanding volatility helps investors gauge the risk associated with an asset and assess the potential for both gains and losses.

Why Volatility Matters in Digital Asset Investments

1. Risk Assessment: Volatility is a key indicator of risk. By understanding an asset's volatility, you can assess its risk level and determine if it aligns with your investment goals and risk tolerance.
2. Price Fluctuations: High volatility can lead to significant price swings, offering opportunities for high returns but also posing risks for substantial losses. Knowing the volatility helps you prepare for these fluctuations.
3. Portfolio Optimisation: Analysing volatility helps in optimising your portfolio by balancing high-risk, high-reward assets with more stable investments

Measuring Volatility: Standard Deviation vs. Variance

Volatility is typically measured using standard deviation and variance. Both metrics quantify the amount of variation or dispersion of a set of values, but they have differences:

Variance: Variance measures the average squared deviations from the mean. It provides a sense of how much the returns differ from the mean return.

Formula:

Variance Formula

where:

• σ  is the standard deviation
• N is the number of observations
• R_i is the return for period

μ  is the mean return

• Advantages:

• Provides a measure of dispersion useful in various statistical analyses.
• Directly related to risk; higher variance indicates higher risk.

• Disadvantages:

• Not in the same units as the original data, making interpretation less intuitive.
• Squared values can exaggerate the perceived level of risk.

Standard Deviation:  Standard deviation is the square root of variance. It provides a measure of dispersion in the same units as the original data, making it easier to interpret.

Formula:

Standard Deviation Formula

• Advantages:

• Expressed in the same units as the original data, making it easier to interpret.
• Provides a clear understanding of the average amount by which the returns deviate from the mean.

• Disadvantages:
• More complex to calculate due to the square root.
• Does not directly measure risk like variance but is derived from it.

Example Calculation from Portfolio Data

Let's illustrate this with a sample calculation:

Given the returns: Returns=[0.0045,−0.0058,−0.0021,0.0024,0.0036,−0.0017,0.0052,−0.0043,0.0031,−0.0025]

Calculate the Mean Return: The mean return is:

μ=0.0012

Calculate Each Squared Deviation: Subtract the mean return from each return and square the result.

Sum of Squared Deviations

Variance

Square Root of Average (Standard Deviation):

The volatility of the sample returns is approximately 0.003880 or 0.388%

Comparing Volatility of Two Portfolios

To understand the implications of volatility, let's compare two portfolios:

• Portfolio A: Returns are similar to the example above.
• Mean Return: 0.0012
• Standard Deviation (Volatility): 0.00388
• Portfolio B:
• Returns: [0.010, -0.012, 0.015, -0.010, 0.020, -0.008, 0.022, -0.014, 0.018, -0.011]
• Mean Return: 0.0040
• Standard Deviation (Volatility): 0.01234

Analysis:

• Portfolio A:
• Lower volatility (0.00388) indicates more stable returns.
• Lower risk, but also potentially lower returns.
• Suitable for conservative investors seeking stable growth.
• Portfolio B:
• Higher volatility (0.01234) indicates more significant fluctuations in returns.
• Higher risk, but also potentially higher returns.
• Suitable for aggressive investors willing to take on more risk for higher rewards.

Practical Applications and Insights from TRAC Alpha Volatility Analysis

1. Track Risk Levels: Regular volatility analysis helps track the risk level of your investments. By monitoring volatility trends, you can identify changes in risk and adjust your strategy accordingly.
2. Identify Trends: Analysing volatility over time can help identify trends and patterns, providing insights into market behavior and potential future movements.
3. Data-Driven Decisions: Understanding volatility enables you to make data-driven decisions about asset allocation, risk management, and portfolio adjustments.
4. Risk Management: Use volatility analysis to assess and manage the risk of your investment portfolio. Balance high-volatility assets with more stable ones to achieve a desired risk level.
5. Comparing Assets: Compare the volatility of different assets to determine which investments align with your risk tolerance and investment strategy.
6. Market Timing: High volatility periods can offer lucrative trading opportunities. By analysing volatility, you can time your market entries and exits more effectively.

How TRAC Alpha Can Help

TRAC Alpha is a powerful tool designed to power institutions in crypto portfolio intelligence. With TRAC Alpha, you can:

• Monitor Volatility: TRAC Alpha provides real-time data and analytics to help you monitor the volatility of your digital assets.
• Analyse Trends: Leverage advanced analytics to identify volatility trends and make knowledgeable investment decisions.
• Optimise Portfolio: Use TRAC Alpha's insights to optimise your portfolio, balancing risk and reward to achieve your investment goals.

Tips for Effective Volatility Analysis

1. Regular Updates: Regularly update your volatility analysis with the latest data to ensure your risk assessments are accurate and up-to-date.
2. Historical Data: Use historical data to estimate future volatility. Analysing past trends can provide insights into potential future movements.
3. Comparative Analysis: Compare volatility across different assets and time periods to identify the best investment opportunities and manage risk effectively.

Volatility is a powerful metric for assessing the risk and potential reward of digital asset investments. By understanding and analyzing volatility, you can make decisions that enhance your portfolio's performance and help you achieve your financial goals. Start incorporating TRAC Alpha's risk management tools into your investment strategy today, and take control of your financial future.

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For more information: www.trac-alpha.com