What is dollar-cost averaging?
Dollar-cost averaging (DCA) is a technique where long-term investors consistently buy an asset they like with small amounts of money repeatedly at a fixed cadence. Instead of going “all-in” on a stock, ETF (exchange-traded fund), or cryptocurrency, DCA investors will “pepper in” a bit of their capital at scheduled intervals.
DCA’s purpose is to level out an investor’s average price they pay for an asset, their cost basis, over time. Since people who use DCA are constantly buying small positions in one investment, chances are they’ll pick up shares at different price points, thus evening out their cost basis.
For example, someone buys one share of Apple (AAPL) on the stock market at $160 one week and another at $150 the following week. The cost basis of these purchases would be $155 ($160 + $150/2 = $155). In contrast, someone who bought two shares of AAPL in the first week would have a cost basis of $160.
How does dollar-cost averaging work in crypto?
DCA in crypto works the same as in any other financial market. An investor will usually set aside money they intend to dollar-cost average into a crypto and set a schedule to make small purchases.
Everyone has a slightly different DCA strategy, but most will invest the same dollar amount in a cryptocurrency on a weekly, biweekly, or monthly basis. For instance, someone can choose to invest $100 of their paycheck in Bitcoin (BTC) every Friday. Alternatively, a DCA investor may decide to invest $400 once per month in Ethereum (ETH). Both of these strategies will be considered DCA.
People who use DCA aren’t interested in “timing” the best buying opportunity in the market. Instead, these investors are focused on the long-term price potential of their chosen asset. Instead of buying a cryptocurrency at rock bottom, a DCA investor wants to gain as much exposure to a crypto they feel will be valuable years down the line. This may be effective as markets are exceptionally difficult to time.
How do investors dollar-cost average in crypto?
A great feature of DCA is that it allows investors to easily adjust it to suit their preferences. In fact, many CEXs allow customers to set a DCA schedule for a hands-off investment strategy. If your CEX offers this feature, you can program how much money to invest in a given cryptocurrency at regular intervals. The CEX will automatically pull money from your cash balance to make these purchases.
Many CEXs offer an automatic DCA feature that buys a token when it falls by pre-set percentage declines. For example, you can set a DCA strategy to invest $100 in Bitcoin when BTC drops by 10% in a 24-hour trading session. In this case, the CEX should automatically make a DCA purchase on your behalf when it registers this 10% move.
For those who don’t mind actively managing the crypto market, they can manually DCA into cryptos when they notice favorable opportunities. Instead of buying cryptos at pre-set intervals, some DCA investors may wait for a significant correction to invest more of their cash. Some people who use DCA increase their purchases during a bear market and ease up during bullish periods.
As long as people are continuously putting money into their favorite crypto projects at a fixed interval, they’re using the DCA strategy.
What are the benefits of DCA?
Long-term investors often consider DCA to be as “stress-free” as crypto investing gets. Here are a few of the potential pros DCA proponents often point out:
- Removes emotion from investing: Emotions like fear or greed often get the better of investors. However, since emotions are inherently irrational, they often lead to poor long-term investment decisions. DCA helps remove emotion from the equation so people can be more disciplined in their investment strategy. It’s important to stay to the fixed interval and amount schedule, as investors many times become emotional as they see their assets gain and lose value. Becoming emotional can cause investors to deviate from the plan, many times resulting in losses.
- An ideal passive investment strategy: With an automatic DCA strategy on a CEX, crypto investors can truly “set it and forget it.” Without thinking about it, people can steadily gain price exposure to their favorite coins and tokens.
- Helps even out market volatility: Since DCA doesn’t try to time the crypto market’s top or bottom, investors don’t have to worry about buying in at “overvalued prices.” Even if a DCA investor starts buying Bitcoin at a local top, they can gradually bring their cost basis down with future purchases. In this way, DCA helps manage the extreme volatility of the crypto market.
- Easy to understand and implement: Unlike arbitrage or leverage trading, DCA doesn’t require much trading experience. New investors can quickly grasp the concept of DCA and put it into practice.
What are the drawbacks of DCA?
Although DCA is a low-risk investment strategy, it doesn’t mean there aren’t drawbacks. Also, short-term traders never make use of the DCA strategy. Here are some disadvantages of DCA:
- DCA will miss the market bottom: It’s impossible for anyone to time a market bottom, but it’s inevitable that people who DCA will miss it. Even if people start DCAing at a cryptocurrency’s bottom, they’ll buy in again at higher prices at some point. Over time, this can increase a person’s cost basis, thus reducing their total gains.
- Trading fees: People who constantly buy crypto with a DCA strategy will have to pay more fees than those who make one lump sum purchase, especially when fees have a base amount and are not just proportional to the amount traded. These trading fees will eat away at a DCA investor’s total earnings. People who want to use DCA in their crypto strategy should compare the average expenses on CEXs and decentralized crypto exchanges (DEXs) to find the best option for their strategy.
- Only advisable for long-term holders: People who use DCA must have a long time horizon and a bullish outlook for their cryptocurrency. Most DCA investors wait for years before they even think of selling. Those who are interested in making quick trades won’t benefit from DCA.
Does DCA reduce an investor’s risk?
DCA might help crypto investors manage their risk by evening out their cost basis. Instead of throwing all their capital into the market and hoping they caught the bottom, DCA investors have time on their side. Even if a crypto falls dramatically after making an initial investment, a DCA investor will bring their cost basis down every time they buy a dip.
However, even if investors use a carefully prepared DCA strategy, there’s always a risk they can lose money. It’s not unheard of for cryptocurrencies to go to zero. Investors must hope the crypto they’re investing in will be worth more whenever they decide to sell. Just because DCA removes some of the volatility risk in the crypto industry doesn’t mean it’s guaranteed to work.
What are the alternatives to DCA?
Despite DCA’s high status with long-term crypto investors, there are plenty of other strategies people can use to navigate the crypto market:
- Lump-sum investing: A lump-sum investment involves purchasing a full position in an asset with a single buy order. Although lump-sum investing shares DCA’s bullish outlook, there’s no potential to lower your cost basis once your total investment is in the market.
- Swing trading: Swing traders buy and sell their target assets within less than two weeks.
- Day trading: True day traders must open and close their positions within one trading session. If a trader holds a stock or crypto for longer than a day, they’re technically in a swing trade.
- Arbitrage trading: Arbitrage trading involves searching for price discrepancies in the same asset across multiple exchanges. Someone using this method will buy a token with a lower-than-average price on one exchange and instantly sell it on another market to profit from the price inefficiency.
- Leverage trading: Leverage trading is a high-risk practice that involves borrowing money from an exchange to increase a person’s price exposure. Since the funds in a leverage account are borrowed, it puts traders at a greater risk for liquidation.
It’s easy to see why many long-term crypto investors use the DCA strategy. No matter your experience level, DCA is simple to understand and easy to put into practice. People don’t need much capital to start a DCA strategy, and using small buys over time helps reduce the stress of crypto investing. Although DCA may help people manage the volatility of these markets, there’s always a potential that people can lose their funds.
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