What is Dollar Cost Averaging?
The Beginner’s Guide
Dollar-cost averaging (DCA) refers to a simple, beginner-friendly investment strategy whereby a person makes small, regularly scheduled investments in a particular asset over a period of time, instead of investing the entire sum at once.
The main idea behind this method is that by purchasing small amounts of an asset at regular intervals, the impact of short-term volatility can be minimized.
To implement this strategy, all an investor needs to do is create a plan to purchase a fixed fiat amount of a particular asset at a predefined interval. For example, an investor with $1,000 can create a simple DCA plan whereby they commit to purchasing $50 worth of bitcoin at the same time every month for twenty months in a row, rather than a single $1,000 purchase.
Timing the crypto market
Most financial markets go through four cycles:
- Accumulation: when buying momentum begins to pick back up after a prolonged period of selling. This is seen as the first stage of a recovering market.
- Markup: when more buyers enter the market – typically those who are less risk averse and have been waiting for stronger conviction in the market.
- Distribution: when profit taking begins and selling pressure starts to build.
- Markdown: when sellers overpower buyers, confidence in the market breaks down and prices fall.
Predicting and capitalizing on each of these market cycles can be difficult, if not impossible, for most investors. This means many often have a hard time predicting exactly when to buy and sell assets in order to maximize their potential gains.
For investors with a longer investment horizon, DCA addresses this challenge by allowing them to constantly accumulate an asset they believe has long term potential, regardless of its short term price changes.
DCA has the added benefit of removing several emotional aspects of trading as well as the headaches that come with attempting to perfectly time each and every market movement.
Dollar Cost Averaging Bitcoin & Crypto
DCA can prove particularly useful when investing in cryptocurrencies, a historically volatile asset class that trades 24/7 on the global markets.
In a falling market, dollar-cost averaging can often result in reduced losses during the downturn and often better gains as the market improves.
For example, an investor who made a single $11,500 investment at the start of 2022 would have $7,400 in their trading account at the start of June 2022,a loss of over 35%. This contrasts to a 0.72% loss, with $11,400 in their account, had the investor used the DCA strategy and purchased $500 of bitcoin per week over the same time frame.
Additionally, dollar-cost averaging over a period of many years can provide better returns than making a single investment. Let’s assume an investor made $5 investments in bitcoin every week for the last four years. By Jan. 1, 2022, they would have made a 460% return using the DCA strategy compared to a 243% return had they made a single investment – a difference of 217%.
Dollar-cost averaging example
|Single Investment||Dollar-cost averaging|
|Date||Amount invested||Portfolio value||Amount invested||Portfolio value|
|Jan. 1, 2018||$1,305||$1,305||$5||$5|
|Jan. 1, 2019||$1,305||$359||$265||$162|
|Jan. 1, 2020||$1,305||$694||$525||$628|
|Jan. 1, 2021||$1,305||$1,420||$1,045||$3,413|
|Jan. 1, 2022||$1,305||$4,488||$1,305||$5,855|
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Why Use Dollar Cost Averaging?
Many investors are drawn to dollar-cost averaging because of its simplicity.
Creating a DCA plan requires little effort and executing the strategy involves placing single trades at set intervals, making it a perfect go-to strategy for beginner traders with a long-term investment horizon.
Additionally, the entire process can be fully automated via features like recurring buys on the Kraken app
This “set it and forget it” capability means investors do not have to consciously remember to make periodic investments; freeing up more time to do other things.
Furthermore, dollar-cost averaging is a great option for long-term bullish traders who simply wish to consistently accumulate a particular asset over time. If used for a consecutive period over many years, a DCA investing strategy could garner good returns.
These materials are for general information purposes only and are not investment advice or a recommendation or solicitation to buy, sell, or hold any digital asset or to engage in any specific trading strategy. Some crypto products and markets are unregulated, and you may not be protected by government compensation and/or regulatory protection schemes. The unpredictable nature of the cryptoasset markets can lead to loss of funds. Tax may be payable on any return and/or on any increase in the value of your crypto assets and you should seek independent advice on your taxation position. Past performance is no guarantee of future results.