What is dollar cost averaging? Explains CryptoNewsHerald

Main

• Averaging is one of the most common methods in trading and investing. It implies a gradual purchase or sale of an asset in small parts, and not for the entire amount at once.
• This strategy allows you to reduce the risk of price volatility by making many small transactions, averaging the “entry point”. It is widely used in transactions in the cryptocurrency market, which is characterized by frequent and significant trend changes.
• Averaging combines many separate tactics and mechanisms. Its most famous version is dollar-cost averaging (DCA).

How to use averaging?

The main feature of the dollar cost averaging strategy is the conclusion of transactions for equal amounts of money at regular intervals. This approach allows you to get a smoothed average purchase price, reducing the risks of volatility for the cost of entry.

DCA requires the development of a deal plan that includes a schedule of operations. They should be done with regular consistency, such as once a week or twice a month.

As an example, let’s take a deposit of $6,000 and an investment horizon of five years. One use case for DCA is to buy an asset once a month for $100 over the next five years.

Is averaging good for selling?

DCA is also actively used when selling an asset. As in the case of invested funds, you can get rid of an asset in equal shares with certain criteria: price level, dates, and the like. This can reduce the risk of an untimely exit from the asset and protect against lost profits.

When is the best time to use averaging?

The DCA method allows you to level the risks of volatility for the entry price and reduce the financial burden for the implementation of a long-term investment plan.

DCA is suitable for buying an asset in a bear market. Instead of predicting a “bottom”, the investor makes trades according to a predictable plan, lowering his average entry point due to the constant decline in the price of the asset.

Averaging assumes that the investor has determined in advance for himself the long-term growth potential of the asset in which he is going to invest. This strategy cannot protect against falling prices.

What are the advantages of this method?

By using average cost averaging, investors gain several important benefits:

1. Lack of emotional decisions. A clear plan of action assumes that all attention is paid to buying or selling an asset in certain periods, which avoids the risks of making counterproductive emotional decisions.
2. Time saving. The point of entry into the market (or exit from it) is determined regardless of specific conditions. This frees up time that could be spent on analytics and constant monitoring of the market situation.
3. Low costs. Not all investors are able or willing to invest a significant amount at once. DCA allows you to create a comfortable plan for any financial opportunity.
4. Price drop is a positive factor. A decrease in the value of an asset during the investment period means an improvement in the average entry price, which increases the expected profit on future growth.

What are the disadvantages of averaging?

The main and integral part of DCA is an increase in the price of an asset in a selected period of time. The method will not bring any benefit if the coin continues to fall in price. For this reason, you should carefully choose an instrument for investment or trading.

In the stock market, DCA is more suitable for investments in index funds like the S&P 500 and Dow Jones, not individual papers. Although, on the Internet you can find many averaging calculators, including those for stocks.

Who uses averaging for cryptocurrencies?

DCA is often used to acquire large amounts of crypto assets in a short time. The most famous people who use cryptocurrency averaging include Twitter founder Jack Dorsey. In 2019, he stated that he invests no more and no less than $10,000 in bitcoin every week.

In 2018, Adam Trademan, CEO of the popular BRD crypto wallet, announced the use of DCA as the main strategy for buying bitcoin. His approach meant buying BTC every few days. According to Trademan, DCA helps to avoid psychological stress when buying an asset for a large amount.

According to analysts, the DCA method is most likely being followed by Microstrategy, which made several large Bitcoin purchases in 2020 and 2021. When reporting on the next acquisition, the company’s CEO Michael Saylor calls the average cost of the purchase.