The cryptocurrency market is known for its fierce volatility which makes it unattractive to less aggressive investors. Investors often wonder about the best approach to cryptocurrency investments, hence the reason for this article.
Dollar-cost averaging (DCA) is an investing strategy where an investor invests a total sum of money in small increments over a period of time as opposed to investing all at once. DCA is designed to help offset any negative effect on an investment caused by short-term market volatility. For instance, if the price of an asset drops during the time you are dollar-cost averaging, then you stand to make a profit if the price moves back up.
DCA is the best approach for individuals who are not professional investors. It can save an investor a lot of effort trying to time the market in order to get the best prices. It is a tool for investing slowly and consistently and it aims to protect against the human tendency of wanting to gain all at once.
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How dollar-cost averaging works
Applying dollar-cost averaging is very simple, and you do not necessarily have to invest in dollars; the approach works well with any other currency. You first have to determine the total amount of money and the cryptocurrencies you wish to invest in. Then, instead of investing the money all at once, you invest it in small equal installments over a specific length of time.
Committing to this approach means, at times, you’ll be investing when the market or a particular asset has dropped in value. It also means there will be times when you’re buying during a market sell-off. Some risk-averse investors might not be encouraged to purchase securities during bear markets, but viewed from another perspective, buying from bear markets allows you to invest in potentially profitable cryptocurrency assets at significantly cheaper rates, especially when they are below their intrinsic value.
By buying when others might sell, dollar-cost averaging can potentially help you to reap the benefits of buying low and selling high.
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Practical example
Say I plan to invest a total sum of $12,000 into the cryptocurrency called EOS, whose previous peak price was around $13.00, and I decide to invest this amount of money equally over the next 3 days (i.e., $4,000 per day) between the 8th of May and the 11th of May, 2021. DCA seeks to reduce the risk of incurring a substantial loss resulting from investing the entire lump sum just before a fall in the market.
As seen from the chart, if I invested the total amount of money at once at the previous peak of $13.00, although I would be in profit today of about 5.08% if I did not dollar cost average (using the current market price of EOS at $13.66), I could have gotten in at an aggregated cost, when the market dipped from the previous peak to around $8.00.
Another observation is that the best time to apply this method is during a bear market where prices have dropped to a low-price zone, as seen in the chart. A potential profit of 30.47% could have been made with an average cost of $10.47 (This price was gotten by taking the average cost of the high and low prices between the 8th and the 11th of May, 2021 and taking the overall average of these days) with the current market price at $13.66.
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With every golden strategy, there are downsides
The most notable downside of DCA is the possibility that you might miss out on a large gain you could have earned if you had invested all your money at once when the market was down.
From the example, if an individual started dollar cost averaging on the 11th of May, 2021, on EOS, a potential gain of 30.00% would have been missed out on. That being said, we must remember that big profits require timing the market correctly which not all professional investors can do. DCA is still a potentially safer way to take advantage of big market dips.
Another downside will be increased transaction charges. Because of the transaction charges of many trading platforms, you’re going to incur more trading costs with a dollar-cost averaging strategy.
Another risk is that you may buy after a steep rise in asset prices and face a downward correction afterwards.
A DCA strategy, over time, usually includes buying assets at any stage, whether it be stable, depreciating, or appreciating. If done consistently, a DCA strategy tends to lower your risk and does better over a long-term horizon.