Trading 101: What is Dollar-Cost Averaging?

This article explains how this long-term investment strategy works and why it’s widely trusted.

What is Dollar-Cost Averaging (DCA)?

During turbulent times, investors are more hesitant to “bet big”. The dollar-cost averaging (DCA) strategy is invented to deal with uncertainties in the market: By increasing their position bit by bit, investors are less susceptible to negative emotions and as a result less likely to make irrational decisions.

Definition

The dollar-cost averaging is a strategy where investors make regular but rather small investments in an asset, gaining exposure to that particular asset gradually over time. 

It protects investors from potential losses due to:

– Picking the “wrong” time: Timing in investing is one of the most important components. Paying a lump sum when the whole market is trading in red can lead to severe losses, especially in extremely volatile markets such as crypto.

– Market fear: Retail investors can be heavily influenced by the overall market sentiment. As far as we know, panic and fear are not really good friends of rationality.

The Benefits

DCA relies on historical data that shows markets do tend to rise with time. It helps investors zoom out, look at the bigger picture and stick with the plan. They also utilise DCA to make efficient capital allocations.

DCA requires self-discipline instead of technical knowledge. It rules out the emotional components, effects of market downturns and reduces the associated risks.

Dollar-Cost Averaging: when and when not

The dollar-cost averaging (DCA) strategy can be applied at any time, but will be of greatest use in the following situations:

– The asset has long-term growth potential: As the saying goes, “do your own research”. We always advise you to analyse the available information carefully before deciding to invest. If an asset has great long-term growth potential, DCA can bring predictable returns with a minimum level of risk.

– Volatile markets: DCA breaks the total amount of capital into small equal chunks, which take place at regular intervals regardless of how the market is performing. There are good days and bad days; the dramatic changes will be averaged out thanks to this strategy.

– Beginners and retail traders: These groups of traders can be easily affected by trends and market sentiment. They also need time to learn several trading techniques. DCA teaches them to be disciplined, be careful with the FOMO (fear of missing out) feeling as well as emotional trading.

As mentioned above, it is best employed in tandem with careful research. Read here for more information on how to do fundamental crypto analysis.

How does DCA work?

You’ll need to decide on the asset to invest in, its potential and reliability, how much capital in total to be allocated to this asset, how often to invest (i.e. the intervals) and follow through. 

Beware though: DCA will not generate magnificent returns overnight, which does happen with some blockchain-based crowdfunding projects. DCA guarantees safe entry into the market and is designed for a longer term approach.

If you want to engage in crowdfunding activities, we recommend starting with a small amount of equity and turn to projects vetted by and launched on renowned exchanges, for example Bitget Launchpad

Example

Assume that we invested US$100 in Bitcoin every week since May 2018. By now, we will have invested US$20,900 in total. We can see the green line, which is our total investment over time, and the orange line that demonstrates our portfolio value. The percentage change of the portfolio should be 309% despite the market’s fluctuations. DCA has therefore helped our investment quadruple in four years without constantly worrying about Bitcoin’s lows and highs.

A Bitcoin portfolio with DCA Strategy.

Source: dcabtc.

The Rules

There is a set of requirements that come with the dollar-cost averaging (DCA) strategy as given below:

(i) Do the research: Make sure that you pick “the right thing” to invest in;

(ii) Stay focused: No matter how bad the asset’s performance is on a day or a week, remember that you commit to purchase it on a regular basis;

(iii) Keep yourself updated: In a digital world, information is the new currency. Follow the project and its team on social media (Twitter, Telegram, Discord, etc.) and pick up the keywords. That also effectively helps with timing the market;

(iv) Zoom out: The crypto industry is dominated by Bitcoin, therefore any sharp fluctuations in Bitcoin prices will definitely impact the whole market. It is also starting to show correlations with other asset classes, for example stocks and interest rates. In short, it’s all related; the more you know, the better prepared you are to deal with unwanted scenarios;

(v) Distinguish between destructive emotions and gut feeling: Examples of destructive emotions include panic selling/buying, FOMO, etc. while gut feelings stem from years of experience and the processing of all relevant market information. Using DCA means you are getting rid of the nasty, irrational voice in your head. But if you have been around for some time, trust your gut feeling. 

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