Investing in cryptocurrency is not easy, even an experienced investor can sometimes get a hit due to the volatile nature of the crypto space. To reduce the risk of investing and to increase the financial returns crypto participants adopt different investment techniques.
Dollar-cost averaging is one of the investing techniques widely used by investors that deals with the volatile nature of the crypto space by automating purchases.
What is Dollar Cost Averaging(DCA)?
Dollar-cost averaging is a proven investment strategy in which crypto participants invest a fixed amount at regular intervals irrespective of the share price. DCA mitigates the impact of fluctuations in the value of assets while investing a large share of financial assets.
This strategy also eliminates the hurdles of time-specific buy and sell to gain the best prices. In a long-term investment, this strategy reduces the average cost per share compared to buying a whole share at once.
By spreading the investment over a prolonged period, the risk of investing a large amount before a share down can be eliminated, thereby reducing the impact of volatility and risk of poorly timed investments.
Advantages of DCA in crypto
Adopting a dollar-cost average investment strategy in a crypto platform can increase the profit over the long term. By following an automatic investment mechanism DCA reduces the risk of human-driven emotions. The main advantages of DCA include
- Mitigate market volatility
DCA allows a trader to invest a fixed amount of dollars at regular intervals regardless of the share price. With a long-term investment strategy, one can mitigate the risk of daily fluctuation of assets. This keeps the investment secure when the price drops suddenly.
- Reduces timing risk
Investing in crypto all at once can create high risk when a market downturn occurs. As the dollar cost average mechanism works on long-term investments, the daily drop-down doesn’t affect the investment and also eliminates the effort of continuous monitoring for best buy and sell. It is difficult to predict a downturn, but choosing dollar cost averaging can help an investor stay away from the timing risks.
How to implement DCA?
Implementing a DCA strategy comprises a number of procedures.
1. Choose the right investment
There are many cryptocurrencies available in the market, and choosing one can be a difficult task for many. Before opting for a cryptocurrency one has to analyze the risk factors and scope of potential returns. Though cryptocurrencies are associated with the risk of volatility, by proper monitoring one can improve their profits. While choosing a cryptocurrency one has to consider factors like liquidity, market capitalization, use case, technology, and security.
2. Setting investment frequency and amount
After choosing the cryptocurrency an investor has to set the amount of investment. In DCA an investor invests a fixed amount of money at regular intervals, so try to set an amount that you can manage for a long period of time.
Once an investment amount is set, a trader has to choose the time frame in which he wishes to hold the investment. It can be weekly, monthly, or quarterly.
3. Automate the investment
For an efficient and smooth investment process, it is ideal to automate the investment through bank transfers or investment apps.
4. Continue the investment process
Continue investing the fixed amounts until the set time limit is attained.
Example of DCA in action
An investor invested $200000 using a dollar cost average strategy. The time frame set is eight weeks with investing $25000 every week.
| Week | Share price | Number of shares purchased |
| Week 1 | 82 | 305 |
| Week 2 | 80 | 313 |
| Week 3 | 78 | 321 |
| Week 4 | 82 | 305 |
| Week 5 | 81 | 309 |
| Week 6 | 83 | 301 |
| Week 7 | 86 | 291 |
| Week 8 | 85 | 294 |
| Total shares purchased | 2437 | |
| Average share price | 82 |
While another person invests the same amount with the same time frame and the same fixed amount but without any strategy.
| Week | Share price | Number of shares purchased |
| Week 1 | 80 | 300 |
| Week 2 | 72 | 309 |
| Week 3 | 78 | 320 |
| Week 4 | 80 | 300 |
| Week 5 | 80 | 305 |
| Week 6 | 74 | 300 |
| Week 7 | 82 | 289 |
| Week 8 | 80 | 290 |
| Total shares purchased | 2413 | |
| Average share price | 70 |
Based on the two tables above, by spending 200000 dollars in total, a person purchases 2437 shares with an average share price of 82 dollars by using the DCA strategy. While the other person only earns 2413 shares with an average price of 70 dollars. This proves that the DCA approach can reduce the cost per share over a long period of time.
Bottom Line
Dollar cost strategy is one of the effective method for traders who intends to invest for a long term. It reduces the impact of volatility in the platform and also mitigates the risk of time-specific investments. However, the transaction cost, the potential for lower returns, and the long wait can make the strategy challenging.