What Is Volatility?
For this article, what we are going to introduce you to is the way the financial markets work.
Although volatility can confuse investors, market movements should not scare you.
Compared to the traditional stock market where plus or minus ten percent volatility is the norm, the crypto market has much more volatility.
The most important thing to understand when investing in cryptos is that they do not work the way you think they work. In everyday life, we are confronted with what we could call "simple systems'', i.e. identifiable casualties. In the years between the wars, there were a number of scientific advances in the field of physics that changed the way we saw the world. There was for example the discovery of quantum physics which explains that the laws of physics for the very small are different than those for larger objects. The second major discovery was that systems did not function in the same way and therefore did not have the same physical laws depending on whether they were simple or complex. It is important to understand this in order to understand the financial markets because we have been educated to try and develop the ability to live in simple systems and despite the fact that we are gifted with very intelligent actions that are therefore adapted to systems, these same very intelligent actions in a complex system do not work.
A complex system is a system that has many more elements than a simple system. And as a physicist from the interwar period said: "more is different". Why do more elements make a major difference compared to few elements? Well, this is because when there are many elements, the internal system generates interactions between these elements, one with respect to the other, which have consequences that we will call volatility and which are different from the long-term direction that this set of elements takes.
To try to be clearer, let's take a very simple example: if you see a flight of ducks in the countryside, you have a dozen ducks flying in one direction from pond A to pond B, this is a simple system because we see the direction and we know the causality.
If you take a complex system such as a flight of starlings, there can be 10,000 or even 20,000 starlings and in this case you will see that this flight marks the skies in volutes because its mode of operation is that of volatility because, for example, there will be a starling that will see a fly, it will try to catch it, that will make move the starling which is located beside the first one which itself will jostle the starling of beside, and thus the whole will make evolve the group of starlings.
So in our previous examples, you see that the starlings will evolve via a very marginal cause: a single starling that will try to catch a gnat. This is what we call chance, when there is a very large distance between the cause and the effect. This path between cause and effect is very difficult to trace when there are tens of thousands of elements or even millions of elements.
This gives systems that we call complex systems and what we know, we know about two things about these systems, is that on the one hand, we do not know how to predict volatility in the current state of our scientific knowledge. We do not have, despite the mathematical power available, a reliable way to predict volatility, so it is impossible to predict the volatility of our starling flight as well as the volatility of the crypto markets or of any other complex system.
Consequences of Volatility
When someone asks a trader if the market is going to go up or down in the short term, well, scientifically, it's a meaningless question and if there is an answer given, well, scientifically, it's also a meaningless answer.
The second thing we can say about this complex system, and this is where you're going to see that it's extremely complicated and that it loses people a little bit, is that complex systems are chaotic because there is no causality unlike simple systems but it's a system within which an identifiable causality can still have an influence. If all of a sudden a hunter comes into a field and shoots at a group of starlings, then the group of starlings will keep its flight but it will go in another direction.
So on the one hand it's impossible for us to say, "we don't know what the crypto markets are going to do" and at the same time say that "if there is a significant external element, it will have an impact, in the case of fear, the markets will go down and in the case of confidence, the markets will go up”. Where it gets even more complicated is that let's say there is a whole team of hunters who come to shoot at the starlings and the starlings go far away because they are very afraid. If we make a parallel with the crypto markets, let's say there is a major crisis in China and the market is very scared so it falls very low, well what happens when the market falls very low is that it will trigger a "Wealth Effect": the cheaper the cryptos are, the more they will be bought. This Wealth Effect will have an impact on the markets and the economy, which in turn will have an impact, etc… This is a situation that we experienced in 1929, the stock market collapsed so the banks collapsed and then one thing leading to another the economy collapsed and the more it collapsed the more it made the stock market collapse. A causality that we can therefore call a vicious circle.
A summary of what has just been presented on the subject of volatility
The first element of the complex system is that it has an intrinsic volatility even if there are external causalities that can influence it. The second element is that the complex system has a meaning and this is what physicists call the Arrow of Time. This sense is what we call in complex systems their irreversibility. This means that a complex system will go in one direction. The direction on the financial markets is bullish on the long road. This increase is approximately 8 to 10% per year. So you see, we have two elements, intrinsic volatility and meaning. The investor also knows that there is a big uptrend, a strong line, and then he knows that around that strong line, there is volatility. From these two elements, we can, once we take into account the laws of the complex system, we can manage to get our bearings and we can manage to improve the management of a crypto portfolio.
That is what we will be doing in an upcoming article to help you get your bearings and give you the elements to navigate the complex global crypto financial system. We are not going to do what many people tell you: "cryptos will go up or down" because we know that does not make scientific sense. Instead, we are going to tell you, "here's where we are, here's what the odds are, here's what you can do, here's what you can't do". And then in other articles, we will not talk about volatility but about the lines of force, always trying to tell you what the lines of force of the market are.
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