Crypto Trading 101 | What Is Dollar Cost Averaging (DCA)?
An overview of what DCA strategy is and its relevance to the cryptocurrency industry.
Day trading in cryptocurrencies holds risks, demands a significant amount of time, and research. Moreover, the volatility in prices of digital assets may lead to active traders losing capital. Hence, many investors prefer strategies which are not only less time-consuming but also hold a fewer risks. Dollar-cost averaging or DCA is one such strategy which investors deploy to build long-term wealth over a significant period of time.
In dollar cost averaging, investment positions are created by investing equivalent amounts of money at periodic intervals. In this article, we discuss what DCA is, why it matters, and how it can help you improve your trading results.
What Is Dollar-Cost Averaging?
Dollar-cost averaging, also sometimes called a ‘constant dollar plan’, refers to an investment plan that benefits investors by eliminating emotion-based action. Using the dollar-cost averaging approach, a trader can navigate price volatility by distributing purchases across predetermined periods of time. Rather than throwing a significant amount of investment into an asset class, an investor opts to invest a predetermined amount weekly, monthly, or even on a semi-monthly basis, undeterred by any changes in price.
Generally, DCA is considered to be a simple and powerful strategy, especially for novice traders or traders who are unwilling to spend too much time on the technical aspects of analyzing the market. Dollar-cost averaging is especially suitable for long-term investors. An investor who utilizes DCA commits to an investment sequence where a fixed amount of funds is invested steadily on a given crypto asset.
While many individuals are terrified to invest or nervous about getting into the market at the right time, the dollar-cost averaging strategy provides you with a committed investment structure. It should also be noted that this investing strategy delivers better outcomes during a bear market.How to Apply Dollar-Cost Averaging
The first step with dollar-cost averaging is to determine the total amount of money you are willing to invest in a given asset. Instead of investing the whole amount simultaneously, you need to spread that amount over a length of time. These investments can either be manual or through mediums such as 401(k) plans that can automatically do it for you. After initiating this plan, purchases happen automatically heedless of any changes in the market value of the crypto asset.
For example, let’s assume that you are planning to invest a total of $3,000 spread across a period of 3 months on ‘C’ tokens. That means that every month you will need to purchase ‘C’ tokens worth $1,000. Furthermore, the price of ‘C’ tokens is constantly fluctuating, which means that your $1,000 will buy a varied number of ‘C’ tokens every month.
Assume the price of C token in January was $10, and you managed to buy 100 C tokens. The following month, the market value of C coins plunged to $5, and you managed to purchase 200 C coins with your $1,000. The next month the market price of C rallies to $25, meaning that you bought 40 C coins. Let’s work with the initial three months.
MonthInvestmentMarket value during purchaseNumber of C tokens bought1 January$1,000$101001 February$1,000$52001 March$1,000$2540
Now, if we were just looking at a table, it’s obvious in hindsight that February would have been the most favorable month to buy. By applying DCA, a trader builds a long-term position while downtrend run its course. Moreover, the trader mitigates a certain amount of risks by buying in downtrend.
Additionally, there is no method for determining the market behavior in the short term. It is easier to make long-term price predictions than gauge what changes will happen next week or month. Additionally, it’s not always feasible to have larger amounts of money to invest at one time; many people might find it much easier to set aside a certain amount each paycheck.
So, the main advantage of the dollar-cost averaging approach is that it amplifies the profitability of your investment by exploiting drops in price. Other notable benefits include preventing the risks associated with mistiming the market, aiding in avoiding making decisions based on emotions, and finally, it is ideal for long-term investors.
Is DCA Feasible for Cryptocurrencies?
Dollar-cost averaging is a suitable investment strategy for any volatile asset class. When it comes to price volatility, cryptos like Bitcoin Ethereum certainly fit the bill. It is difficult to foretell the prospects of price movements, but buying dips frequently can be highly profitable.
Across the crypto industry, the general consensus is that DCA is generally a much safer investment approach than investing the entire amount at once.
Bottom line, DCA is a powerful investment approach, particularly for novice investors and those unwilling to bother themselves with frequent technical analysis. Moreover, with its large price fluctuations and the potential for expansion in the future, HODLing cryptos remains a very profitable investment method.