What is Dollar Cost Averaging (DCA) & When it can be a smart strategy
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Dollar Cost Averaging (DCA) is a very popular trading strategy used by both cryptocurrency traders and stocks alike.
DCA can be used to lower the entry price point over time. It can also be a very useful method to remove the emotions from investing.
With DCA you don’t need to worry about timing the market.
I will in this article try to explain what DCA is and when it is smart to use this investment strategy.
Dollar Cost Averaging explained
The concept of DCA means that via several purchases of a specific asset (cryptocurrency) over multiple occasions the overall purchase cost can be reduced.
In what kind of scenarios would Dollar Cost Averaging make sense for you?
- You’ve bought a cryptocurrency at the heigh of its price. And after a subsequent fall buying this asset at a lower price will also lower your average buy-in price.
- You buy an asset on repeated occasions, for example on a monthly basis ($500 in January, $500 in February, $500 in March, etc) and overall you will buy the asset when the price is both low and high – this could lower the average buy-in price
Dollar Cost Averaging scenarios explained
Let me explain each scenario in more detail.
Scenario 1 – you bought at the top
Lets say you invested in Bitcoin during the heights of 2017/2018. During this bull run of Bitcoin we saw the price increase to over $20k for 1 BTC.
After that Bitcoin fell to lower $3000s.
If you bought $1000 worth of BTC at $20k and never bought anymore BTC then your average buy-in price for Bitcoin would be $20k.
But if you would have bought $1000 worth more of BTC when the price was $3500 in January 2019, then your total average buy-in price for that $2000 would be $11,750 per BTC purchase.
That means the initial investment of $1000 when BTC was valued at $20k doesn’t look so bad anymore as your average buy-in price is now $11,750.
Scenario 2 – buy on a repeated basis
The other and more common method is that you buy the asset on a repeated basis over time. This is often done on a monthly basis.
If you believed that Ethereum represented a smart investment and you have read that the cryptocurrency market was very volatile and due to the effects of the coronavirus you weren’t sure when the right time was to buy in at.
Instead of investing $2.5k all at once, you could instead set up monthly $500 purchase orders of ETH.
Let’s say that you would first buy $500 of ETH when it was valued at $239, then the second time it was valued at $258, then the third time $228, fourth time $221 and fifth time $234.
These five separate purchase orders of $500 worth $2,500 would give you an average price of $236.
And these five purchase orders of ETH worth $2,500 would give you a total of 10,6 ETH. And if you would have bought up the entire lump sum of $2,500 when ETH was valued at $239 it would have given you 10,4 ETH.
With DCA you lowered your average buy-in price to $236, and you increased your overall holdings by 0,2 ETH.
|Order #||Amount||ETH price||ETH purchased||Average price||Total ETH purchased|
Why Dollar Cost Averaging can be a great investment strategy
No one can predict the market. If someone says they can, they are probably lying or they have over-belief in their own trading skills.
With DCA you invest smarter over time. Without trying to time the market or investing with your emotions.
With Dollar Cost Averaging, you take a lot of the emotion and fear out of investing because where the market goes in the short-term is far less important to you, as long as you stick to a regular investment plan.Nasdaq
For example, no one could predict the huge effects that the coronavirus would have on the world and the economy. And to avoid feeling bad during a market downturn or recession you could make it into an optimal investment time with DCA.
When others are trying to time the market, and wait for the right time to buy you instead make use of your investment strategy with confidence knowing that you don’t need to chase the heights and falls.
Removing the emotion out of investment can be one of the greatest trading tools a smart investor got.
Another aspect is that it removes certain risks. By keeping some of your money out from the market you can lower your overall risk exposure.
Who should look into DCA?
There are hundreds of different trading and investing strategies available. Not every strategy appeals or makes sense for all traders.
Not everyone have the same investment goal or risk appetite.
I myself am investing for long term value growth and portfolio diversification. I don’t necessarily feel bad when Bitcoin falls $1000 in a few days. Because I am not investing in Bitcoin for the short term.
So I don’t concern myself with the falls or rises in price.
So for someone like myself DCA would be a useful long term strategy.
It would also be useful strategy for those that:
- Fear they can’t time the market
- Have a low risk-appetite to investing
- Bought in at an all-time high (ATH)
When would DCA not make sense?
Dollar Cost Averaging might not always be the most lucrative strategy and sometimes it is better to invest in one lump sum.
For example if you have money to invest that is perhaps sitting in a savings account or your normal bank account and something unique like Covid-19 happens which had huge effects on the global market.
Then it actually meant that many investment assets fell in price due to the global effects of the Coronavirus.
Another key point is that the overall stock market and cryptocurrency market over time is steadily increasing in value. That means the earlier you get in the bigger the chance can be to get in at a lower price point.
Especially when you think of the effect compound interest can have on your overall portfolio
Who is DCA for and who is it now for?
I can try and summarise who DCA might a useful strategy for and who it might not be useful for
DCA can be smart for people that:
- Are risk-averse
- Are afraid of investing in a big sum and timing the market
- Can only invest a small sum at a time
- If you happened to invest at an ATH (All-Time High)
DCA might not be the best for people that:
- Have a high risk-tolerance
- Strongly believe an asset will rise in value over time
- Wants maximum exposure to the market
You might see the term DCA, or Dollar Cost Averaging if you read online forums or trading blogs. So now you have a good understanding of what DCA is, and when DCA might be a smart investment strategy.
It might not be the right for you. It depends on your goals with this particular investment asset, and also what type of risk-appetite you are content with.
More helpful guides:
- Beginner’s guide to investing in cryptos
- Our best tips to protect your cryptos
- What 2FA is and why you should use it
- What crypto volatility is
- Guide to popular MetaMask
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My name is Per Englund and I’m a long-term fan and investor of Bitcoin and other cryptocurrencies. I’ve been around the space for a good few years, learning how it all works and to be a part of this engaging community.
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