The term “Dollar Cost Averaging” has appeared frequently across several financial markets, services and trading and refers to a specific type of investment technique while trading forex, CFDs or shares or even cryptocurrencies. The technique typically involves buying a fixed dollar amount of a particular type of investment, by following a regular schedule, regardless if the price falls or rises. Typically the investor needs to purchase more shares when price levels decrease and the opposite when price levels recover.
Breaking Down Dollar Cost Averaging in the Crypto Context
As mentioned before, Dollar cost averaging techniques involve the investor, dedicating a fixed dollar amount religiously each month on a particular investment. In fact, dollar-cost averaging is a trading technique that can be applied to a number of investment options including mutual funds, exchange-traded funds, individual stocks and, in this case, cryptocurrencies. In this article we will focus on the context of implementing dollar-cost averaging techniques in the Cryptocurrency market.
The Cryptocurrency market, in general, has been attracting investor’s attention all around the world, even more so since the market practically grew exponentially since 2016. Crypto-analysts everywhere agree that the value of the total Cryptocurrency market will reach $1 Trillion. Indeed the world is experiencing a “crypto-storm” as hundreds of small-time traders, big investors, venture capitalists and even some MNCs are looking to get into the action. In discussing various Cryptocurrency trading techniques within the community, the dollar cost averaging technique is probably the most effective, if not fool proof.
Scenarios That Support Dollar Cost Averaging Technique in Cryptocurrency Market
Several traders have achieved success by implementing the dollar cost average technique in varying degrees in the crypto-market. Most notably, such phenomenon can be seen among Bitcoin traders who “buy the dips and sell the tops”. Most Bitcoin investors purchase small amounts of cryptocurrencies to make this work. Applying the dollar cost averaging technique in the Cryptocurrency market allows similar patterns as in other markets, explained in brief below.
· A falling market
· A ‘sideways’ market trend
· A ‘rising’ market
Implementing DCA techniques for Crypto gains
DCA techniques can be implemented for effectively trading Bitcoins with a profit. However, it is to be noted that following this technique comes with a lot of risks, especially for the novice traders. Another factor is Bitcoin’s volatility which cannot be readily predicted. That being said, the best ways to use the DCA technique for cryptocurrencies are mentioned below. For the sake of simplicity, we will take the example of Bitcoin Trading.
· Using DCA for “HODL”ing:
This technique is best used by Bitcoin hedgers, which refer to investors who hoard Bitcoins for long-term gains. Traders and investors who believe that Bitcoin’s value will appreciate or at least hold its ground over a long period. Following this technique requires the traders to allocate a fixed dollar amount worth of Bitcoins no matter what the price or prevalent market conditions are.
The term HODL loosely refers to the phrase “Hold on for Dear Life”, referring to the act of holding on to a particular token no matter what the situation is. Investors who HODL are called Hodlers. Hodlers normally indulge in day trading or even using intra-range strategies to reach their goals. Using the DCA technique is helpful in this case as traders are not required watching daily price charts to catch rises and dips. Most investors who use DCA for hodling are long-term investors, intent on holding a large number of tokens for the long run
· In case of recurring purchases:
Recurring purchases in Cryptocurrency trading is offered by some companies, notably Coinbase and Blockchain.info. Recurring purchases refers to a platform that allows the trader to set a desired amount of Bitcoins or any other tokens which the trader has to purchase on a set date. The service then deducts funds from the trader’s bank account.
Real World Example Using Bitcoin
Let’s say a trader wants to invest in Bitcoin. The market as a whole and the price of Bitcoin as mentioned above is characterised by volatility and is not expected to change anytime soon. This makes finding a comfortable entry point in the market, a tricky affair. Both the market and Bitcoin can go up just as easily as they can go down. If the trader wants to get the best price to buy in, using the average price by applying the dollar cost averaging method is the best option.
A general rule is that dollar cost averaging over a longer period of time decreases the risk you’re exposed to. If you decide to invest 10% of your budget every week, your risk exposure is much higher than when you decide to invest 10% every month.
It is to be noted that dollar cost averaging over a longer period of time decreases a trader’s risk exposure, For example, if a trader decides to invest 10% of their budget every week, he/she’s risk exposure will be much higher than in the case of investing 10% per month.
Short Steps for Setting Up Dollar Cost Averaging Plan
There are ‘three’ important things that a beginner has to keep in mind while setting up a dollar cost averaging plan.
· The novice trader has to first decide the amount s/he can invest per month (at a regular interval, most effective if done weekly). If the amount to be invested is not decided prudently then the dollar cost averaging technique will not prove to be so effective.
· It is also important to determine the crypto coin in which the novice trader wants to invest on. For this, the investor has to analyse the cryptocurrencies previous market performance, the whitepaper, and the company’s future prospects and so on. It is important to decide whether the goal is short-term returns or long-term returns. Long-term in case of cryptocurrency means from one month to a few months.
· The investor also has to decide what regular intervals mean to him or her. It can be weekly, monthly, quarterly, etc. if the investor is bent on shares market. But for the cryptocurrency market, it is advisable to give a week (at the most two weeks) gap between each investment. Many brokers also offer automatic withdrawal plan for little or zero expense.
As seen from the instance given in the article, the beginners should study the market sentiment properly and analyse the historical price charts prudently. The dollar cost averaging technique best work for a ‘falling’ market. It can also be used judiciously in a sideways market and rising market (short-term goal). The most important plus point is that the technique helps the investor to avoid mistiming the market. The dollar cost averaging technique in the cryptocurrency market tries to smooth out the extreme instability. The technique also creates a distance such that the investor does not commit any mistake, being overcome with emotion. Lastly, the beginner should think about long-term profit with this technique.