Price volatility in cryptocurrencies such as Bitcoin can occur on a daily (or even hourly) basis. Volatility, like any other type of investment, can cause uncertainty, fear of missing out, or fear of participating at all. How do you know when to buy when prices are fluctuating?
In an ideal world, it’s as simple as buying low and selling high. In reality, even for experts, this is easier said than done. Rather than attempting to “time the market,” many investors employ a strategy known as dollar-cost averaging (or “DCA“) to mitigate the impact of market volatility by investing a smaller amount in an asset — such as cryptocurrency, stocks, or gold — on a regular basis.
DCA may be the best option for someone who believes their investments will appreciate (or increase in value) in the long run but will face price volatility on the way.
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What is DCA?
DCA is a long-term strategy in which an investor buys smaller amounts of an asset over time, regardless of price (for example, investing $100 in Bitcoin every month for a year, rather than $1,200 all at once). Their DCA schedule may change over time, and it may last a few months or many years, depending on their goals.
Although DCA is a popular way to buy Bitcoin, it isn’t unique to crypto — traditional investors have been using this strategy to weather stock market volatility for decades. You may already be using DCA if you invest through your employer’s retirement plan every payday.
Benefits of DCA
DCA can be an efficient way to own cryptocurrency without the notoriously difficult work of market timing or the risk of unintentionally using all of your funds to invest “a lump sum” at a peak.
The key is to choose an affordable amount and invest on a regular basis, regardless of the price of an asset. This has the potential to “average” out the cost of purchases over time, reducing the overall impact of a sudden price drop on any given purchase. And, even if prices fall, DCA investors can continue to buy as planned, with the potential to earn returns as prices recover.
When is DCA More Effective Than Lump-sum Investing?
DCA can help an investor enter a market safely, begin benefiting from long-term price appreciation, and average out the risk of short-term price movements. And in situations like the ones listed below, it may provide more predictable returns than investing a large sum of money all at once:
- Purchasing an asset that has the potential to increase in value over time. If an investor believes that prices are about to fall but will likely recover in the long run, they can use DCA to invest cash over the time period in which they believe prices will fall. If they are correct, they will benefit from acquiring assets at a lower cost. Even if they are incorrect, they will have investments in the market as the price rises.
- Volatility is used to hedge bets. DCA exposes investors to price movements over time. When a market experiences price volatility, this strategy aims to average out any significant increases or decreases in their portfolio and benefit from price movement in all directions.
- Keeping FOMO and emotional trading at bay. DCA is a rule-based investment strategy. Beginner traders frequently fall victim to “emotional trading,” in which buying and selling decisions are influenced by psychological factors such as fear or excitement. These factors can cause investors to manage their portfolios inefficiently (think: panic selling during a downturn or overbetting due to fear of missing out on exponential growth).
How Does DCA Actually Work?
Of course, the success of any DCA strategy is still dependent on market conditions. Let’s look at an example using real-world prices as they approached Bitcoin’s biggest downturn to date. If you invested $100 in bitcoin every week beginning on December 18, 2017 (near the year’s price peak), you would have invested $16,300. However, your portfolio would be worth approximately $65,000 on January 25, 2021, representing a return on investment of more than 299 per cent.
Going “all in” as prices are peaking, on the other hand, is generally considered a bad idea — but how could you know? If you had invested the same $16,300 on December 18, 2017, you would have lost nearly $8,000 over the first two years. Although your portfolio would recover, you would have missed out on the opportunity to compound your profits in the interim (and maybe even scared yourself into selling your bitcoin at a loss).
Assume you waited a year and invested $200 in bitcoin every month from December 2018 to December 2020. In this case, your portfolio would be slightly more than $13,000 in 2020, compared to $23,000 if you invested a lump sum. This “all-in” investment would have yielded a higher profit, but it would also have been riskier because any significant price movements after your initial investment date would have affected your entire investment.
Build Wealth Over Time
Building wealth requires as much patience as it does timing. Cryptocurrency assets move in cycles and compound over time. Long-term investors in the crypto world are more likely to prosper than short-term traders. Traders use technical analysis to forecast future patterns of a coin based on its historical performance, trade volumes, and other indicators. These indicators, on the other hand, serve as a guidepost rather than the holy grail. Until the market reaches a certain level of maturity. Timing the market with short trades, for example, is most harmful when a tweet from an influencer does not swing the momentum. Investing and forgetting is a better strategy than obsessing over daily patterns.
The entry point
Dollar-Cost Averaging is a tried and true method of managing entry points (DCA). DCA is a simple investment strategy that works regardless of an asset’s current price. Investors who use DCA divide their investment pool and buy assets at regular intervals. This strategy reduces volatility risk by preventing an entry at a single price point.
Timing the exit
While entry points provide opportunities for portfolio growth, exits are when profits are realised. Each investor should be prudent in withdrawing their principal as well as some profits along the way once a specific price target is reached in the future. If the market enters a bear phase (a period of falling prices), consider re-entering to realise future gains.
2022 Is Still Early To Invest
In a world of 7.8 billion people, there are approximately 120 million cryptocurrency investors. The adoption rate is rapidly increasing, but there is still room for growth. In comparison to the global stock market capitalisation of approximately $100 trillion, the cryptocurrency market is currently valued at less than 2%. So, for most investors, entering on any day in 2021 will suffice.
The only consideration for investment today is determining which cryptocurrencies will still exist in five years. Bitcoin, Ethereum, and other large market cap coins have a higher probability of existence and are thus safer, to begin with.
Wrapping It Up
Dollar-cost averaging is all about hedging your bets: it limits your potential upside to offset potential losses. It works to reduce your chances of suffering serious losses to your portfolio as a result of short-term price volatility, making it a potentially safer choice for investors.
To determine whether DCA is the best strategy for you, consider your specific investment circumstances. Before embarking on a new investment strategy, it is always advisable to seek the advice of a financial professional.