Standard Deviation (Stocks vs. Bitcoin)

One simplified risk metric

Return is a simple metric that is readily understood. You invest. You either make money or lose money. Then, you compare it to your starting amount of money. Up or down X%.

We saw in the return frequency distributions that stocks and bitcoin have quite different risk profiles. While that visualization gives us a lot of information, the downside is it’s complexity. If return can be simplified to one number, it would be helpful to do the same for risk.

Fortunately, we can simplify! While the approach isn’t perfect, it is common to use standard deviation to distill the risk profile of an investment into a single number. Here’s what that looks like for stocks and bitcoin alongside returns:

In this simple chart, we can quickly get a sense for the risk and return profiles for each investment. Over this short time frame, bitcoin had a higher return than the stock market but also a much higher standard deviation. On any given day, you would expect larger swings up and down holding bitcoin. However, if you could handle the volatility, you would’ve been rewarded with some extra gains.

This is just one simple example taken over a very particular timeframe. These metrics do simplify the full day-by-day and minute-by-minute history of these investments but still give us a lot of useful information very quickly. In practice, we could easily pick a variety of different time frames and quickly calculate and compare results. That’s super useful when analyzing potential investment options.

With all of that being said, there is still one more step we can take to create another powerful risk/return metric. Perhaps the answer is obvious but, if not, we’ll take a look in the next post!