What Is Dollar-Cost Averaging?
A detailed guide for beginners on the trading strategy that is dollar-cost averaging.
In the volatile market that is cryptocurrency trading, you will need every advantage you can get to ensure that you stay abreast of the crypto market and either break even or make consistent profits.
After covering scalp trading earlier, this article will explain the dollar-cost averaging strategy in detail so that you can compare it to other trading strategies and make an informed choice about which trading strategy to go with in different situations.
WHAT IS DOLLAR-COST AVERAGING?
The concept of Dollar-cost trading was created by Benjamin Graham, mentor to famed investor Warren Buffet. Similarly to scalp trading, dollar-cost averaging is a trading strategy that helps crypto traders eliminate emotion & risk from their trading decisions by splitting the original sum to be invested into smaller sums and spreading those smaller sums across regular intervals.
In a market as volatile as the crypto market, prices can swing wildly from one minute to the next. Choosing to invest these pre-set amounts into your portfolio at regular intervals means that regardless of any price changes, your portfolio/investment is exposed to minimal risk while at the same time ensuring that your market exposure is maximized.
For example, if you choose to invest $10000 in Bitcoin, a way to implement the DCA strategy would be to split that sum into 20 smaller ones of $500 each. This means that if you choose to invest once a week, for 20 weeks (five months), you buy $500 dollars of bitcoin, no matter the price.
As your investments are spread out over a particular period, the quick changes the crypto market is notorious for has less of an effect on your holdings as the total cost of your investment is spread out, allowing you to, in a way, hedge your bets.
Simply put; in a bull market, your portfolio is expected to increase in value over the set period and in a bear market, you can gain assets at a discount if you continue investing over that same time period (this latter option is based on the assumption that the crypto coin you’re investing in will rise again).
This approach works for both novice and experienced traders even though it could be more beneficial to newbies as it could allow them to avoid the sometimes too technical part of market analysis.
For experienced investors who are patient and can read the market properly, this strategy is especially invaluable in a bear market as it allows patient investors to snatch up good investments at cut-rate prices while hedging the bet by spreading the investment over a period of time to mitigate the risk. This strategy is commonly called “buying the dip”.
HOW DOES THE DOLLAR-COST AVERAGING STRATEGY WORK?
The main aim of dollar-cost averaging (DCA) is to ensure that bear markets are exploited without committing too many funds to one particular trade by taking advantage of market drops and then flipping that investment into a quick profit once the value climbs.
To begin a DCA strategy, you set aside the amount you want to trade with, make a list of the crypto assets you want to acquire and then split the amount into several smaller amounts to invest over a particular time period.
There are two ways by which DCS trades can be set up; manually or automatically. To use this strategy on the Obiex Finance platform, you will need to make the trades manually by executing the trades whenever the price of the crypto you’d like to buy drops within your target range.
Now, there are two scenarios where a DCA strategy can help you as a trader; in a bear market or in a bull market:
Dollar-Cost Trading in a Bear market:
A bear market is the preferred option to implement the DCA strategy as it gives you the chance to obtain crypto assets cheaply with a view to selling them off for a profit when a bull market comes around.
For example, the Chinese government cracked down on cryptocurrency mining earlier this year, leading to a drop in the value of Bitcoin. A savvy investor in the previous example would take advantage of that drop by buying $500 worth of Bitcoin every week for 5 months until the $10000 was used up, safe in the knowledge that the value of the Bitcoin would still rise later.
Over that period, the 5 months carefully buying up bitcoin will help you build a long-term position while the value of the Bitcoin is still on a downtrend, ahead of the expected resurgence. Spreading the investment over that 5-month period has helped you mitigate some of the risks of buying in a downtrend.
It is important to note that this strategy is also risky – [side note; there is no crypto trading strategy that isn’t]. However, because you have spread out the investment over a period of time, your investment is less likely to be lost because you will be buying up Bitcoin at different prices over that five month period.
Dollar-Cost Trading in a Bull market:
In a bull market, you’ll buy crypto assets the same way you’d do in a bear market. The difference, however, is that the buying prices are higher and gives you less chance to make (substantial) profits. There will still be price swings that will guarantee you small profits when the market climbs again but the game for investors in a bull market is ensuring that they remain patient and take advantage of what the market offers.
While a bear market is the best way to use this strategy, waiting for a bear market is not always a feasible strategy as predicting the bottom of a market is hard, even for the most experienced investors.
Another thing to avoid while using the DCA strategy is trying to precisely time the market by waiting for the precise moment a crypto value is at its lowest to start trading. While patience is an important attribute to have if you’d like to use this strategy, you will also need to have a good sense of timing and execute trades immediately when they enter a set range.
Setting a range to start trading at and maintaining the trades over that set period allows you to get in while the market is low and buy the crypto asset at whatever value it falls/rises to over the set period. This is what hedges your bets and gives your investment a chance to grow.
PROS AND CONS OF DOLLAR-COST AVERAGING
DCA is one of the best trading strategies around for both novice and experienced crypto traders but just like other trading strategies, it has its advantages and disadvantages:
- Manage risks: It allows you to hedge your bets by spreading out your investments over a longer period.
- Eliminates emotional investments: As you’re committing yourself to investing over a specific period of time, changes to the value of your investment wouldn’t matter. This enables you to focus on just executing the trades over your set period
- Transaction fees: You’re executing different trades over a long period of time that can lead to an accumulation of transaction fees. Trading with Obiex removes this disadvantage as the trading platform does not levy any fees on transactions.
- Uncertainty: If you buy when a crypto asset’s value is low, you’re buying based on the assumption that it will rise later and it usually does. In the rare instance that it doesn’t rise again and it crashes however, that’s a big problem.
- Volatility: The crypto market is very volatile and this can help if you’re buying in a bear market. If you’re buying in a bull market however, that can be a problem as there are many variables that can negatively affect the value of the crypto you’re holding.
- Only suitable for the long-term: This strategy is a long-term strategy and most of the time, will not yield immediate dividends. If you have a short-term need for money, you should not be using this strategy.
- Can I use DCA as a rookie trader?
Yes you can. The way it is set up means that it is perfect for rookie traders. All you need is some patience and the knowledge to execute trades at the right time and you’re good to go.
2. Will I be charged a fee to make DCA Trading transactions?
Most exchanges will charge a fee on all transactions, making this trading strategy a potentially costly one for you. Luckily for you, on Obiex you can swap stable coins for volatile coins and vice versa without being charged.
3. Is DCA suitable for crypto investments?
Because of the volatile nature of the cryptocurrency market, this trading strategy might be the best trading strategy for long-term investors as it allows you to take advantage of market changes while still keeping your investment (comparatively) safe.
This is one of the best cryptocurrency trading techniques available, equally effective for both novice and experienced traders. As long as you research the market properly and remain patient, this trading technique will bear dividends for you and ensure that more often than not, you come out of trades with more than you put in.
Disclaimer: This article was written by the writer to provide guidance and understanding of cryptocurrency trading. It’s not an exhaustive list and should not be taken as financial advice. Obiex Finance will not be held responsible for your investment decisions.