Cryptocurrencies like Bitcoin can experience daily (or even hourly) price volatility. As with any kind of investment, volatility may cause uncertainty, fear of missing out, or fear of participating at all. When prices are fluctuating, how do you know when to buy?
In an ideal world, it’s simple: buy low, sell high. In
reality, this is easier said than done, even for experts. Instead of trying to
“time the market,” many investors use a strategy called dollar-cost
averaging (or “DCA”) to reduce the impact of market volatility by
investing a smaller amount into an asset — like crypto, stocks, or gold — on a
regular schedule.
DCA might be the right choice when someone believes their
investments will appreciate (or increase in value) in the long term and
experience price volatility on the way there.
WHAT IS
DOLLAR-COST AVERAGING?
DCA is a long-term strategy, where an investor regularly buys
smaller amounts of an asset over a period of time, no matter the price (for
example, investing $100 in Bitcoin every month for a year, instead of $1,200 at
once). Their DCA schedule may change over time and — depending on their goals —
it can last just a few months or many years.
How to Invest in Stocks Market
Although DCA is a popular way to buy Bitcoin, it isn’t unique
to crypto — traditional investors have been using this strategy for decades to
weather stock market volatility. You may even use DCA already if you invest via
your employer’s retirement plan every payday.
WHAT ARE
THE BENEFITS OF DCA?
DCA can be an effective way to own crypto without the
notoriously difficult work of timing the market or the risk of unwittingly
using all of your funds to invest “a lump sum” at a peak.
The key is choosing an amount that’s affordable and investing
regularly, no matter the price of an asset. This has the potential to “average”
out the cost of purchases over time and reduce the overall impact of a sudden
drop in prices on any given purchase. And if prices do fall, DCA investors can
continue to buy, as scheduled, with the potential to earn returns as prices
recover.
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DCA can help
an investor safely enter a market, start benefiting from long-term price
appreciation, and average out the risk of downward price movements in the
short-term. And in situations like the ones below, it may offer more
predictable returns than investing a lot of cash at once:
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Buying an
asset that may increase in value over time. If an investor thinks
prices are about to go down — but are likely to recover in the long term — they
can use DCA to invest cash over the period of time they think a downward
movement will happen. If they’re right, they’ll benefit from picking up assets
at a lower price. But even if they’re wrong, they’ll have investments in the
market as the price increases.
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Hedging
bets through volatility. DCA exposes investors to prices across time.
When a market experiences price volatility, the goal of this strategy is to
average out any dramatic increases or decreases in their portfolio and to
benefit a little bit from price movement in every direction.
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Avoiding
FOMO and emotional trading. DCA is a rule-based approach to investing.
Often, beginner traders fall into the trap of “emotional trading”, where buying
and selling decisions are dictated by psychological factors like fear or
excitement. These can lead investors to manage their portfolios ineffectively
(think: panic selling during a downturn or overbetting due to fear of missing
out on exponential growth).
HOW DOES
DCA WORK IN PRACTICE?
Of course, the success of any DCA strategy is still subject to what’s happening in the market. To demonstrate, let’s dig into an example using real-world prices, right as they approached Bitcoin’s biggest downturn to date. If you invested $100 in bitcoin every week starting on December 18, 2017 (near that year’s price peak), you would have invested a total of $16,300. But on January 25, 2021, your portfolio would be worth approximately $65,000 — a return on investment of more than 299%.
Portfolio value over time
| Dollar-cost averaging | Lump sum investment | |||
|---|---|---|---|---|
When you invest a large sum of money in a single trade, for
example, you're more likely to feel regret if that trade turns out to be poorly
timed. Behaviorial economists note that most people are inherently
loss-averse—they tend to react more strongly to losses (or the prospect of
them) than to gains. But with dollar cost averaging, you're investing smaller
sums of money over time, making it easier to stomach a poorly timed investment.
There's also anchoring bias, in which an investor may refuse to sell an investment bought at a historical high because he or she thinks it's still "worth" that value. By dollar cost averaging into a position, an investor may be less likely to cling to a single price anchor, making it easier to buy and sell according to a predetermined plan