What is Dollar-Cost Averaging and how use it?

Fri Apr 14 2023

DCA or Dollar cost averaging is a good way to mitigate risk associated with timing volatile markets such as cryptocurrency. Here's all about dollar cost averaging.

Like many investors, you might be looking for an investment strategy that is less demanding and time-consuming, or just a more passive investment style. Even with an algorithmic trading strategy, you will most likely need to keep periodically adjust approach to fit the new market paradigm, as there is no strategy that will work in all market conditions.

On our Algorithmic crypto trading platform, Æsir you have the freedom to create unique strategies based on technical analysis, market volatility and more. You can also do away with the complexity and set up an algorithmic DCA strategy.

In this article, we’ll focus on exploring what DCA, or dollar-cost averaging is,and how it provides an easy way to mitigate some of the risks of entering a position.

What is Dollar-Cost Averaging (DCA)?

Dollar-cost averaging is an investment strategy that aims to reduce the impact of volatility on the purchase of assets. It involves buying equal fiat amounts of the asset at regular intervals. By entering a market like this, the investment may not be as subject to volatility as if it were a lump sum (i.e., a single payment).

Buying at regular intervals can smooth out the average price. In the long term, such a strategy reduces the negative impact that a bad entry may have on your investment.

Why Use Dollar-Cost Averaging?

The main benefit of dollar-cost averaging is that it reduces the risk of making a bet at the wrong time. Market timing is among the hardest things to do when it comes to trading or investing. Often, even if the direction of a trade idea is correct, the timing might be off – which makes the entire trade incorrect. Dollar-cost averaging helps mitigate this risk.

If you divide your investment up into smaller chunks, you’ll likely have better results than if you were investing the same amount of money in one large chunk. Making a purchase that’s poorly timed is surprisingly easy, and it can lead to less than ideal results. What’s more, you can eliminate some biases from your decision-making. Once you commit to dollar-cost averaging, the strategy will make the decisions for you.

Dollar-cost averaging, of course, doesn’t completely mitigate risk. The idea is only to smooth the entry into the market so that the risk of bad timing is minimized. Dollar-cost averaging absolutely won’t guarantee a successful investment – other factors must be taken into consideration as well.

How Does Dollar-Cost Averaging Work?

The appeal of a DCA strategy is that you don’t have to try and time the market. As such, if you have dollar-cost averaged into a position, you might also need to consider your exit plan. That is, a trading strategy for getting out of the position.

If you’ve determined a target price (or price range), this can be fairly straightforward. You divide up your investment into equal chunks and start selling them once the market is closing in on the target. This way, you can mitigate the risk of not getting out at the right time. However, this is all completely up to your individual trading strategy. On Æsir you can have an algorithmic DCA strategy with pre-defined Stop Loss and Take Profit, that will automatically close positions for you.

It’s also possible to adopt a “buy and hold” strategy, where essentially the goal is to never sell, as the purchased assets are expected to continually appreciate over time. However, it’s worth keeping in mind that this kind of strategy is usually geared towards the stock market and may not apply to the cryptocurrency markets.

Dollar-Cost Averaging Example

Let’s look at this strategy through an example. Let’s say we’ve got a fixed dollar amount of $10,000, and we think it’s a reasonable bet to invest in Bitcoin. We think that the price will likely range in the current zone, and it’s a favorable place to accumulate and build a position using a DCA strategy.

We could divide the $10,000 up into 100 chunks of $100. Each day, we’re going to buy $100 worth of Bitcoin, no matter what the price. This way, we’re going to spread out our entry to a period of about three months.

If Bitcoin has just entered a bear market, and we don’t expect a prolonged bull trend for at least another two years, we could divide the investment into 100 chunks of $100 again. However, this time, we’re going to buy $100 worth of Bitcoin each week. There are more or less 52 weeks in a year, so the entire strategy will execute over a little less than two years.

This way, we’ll build up a long-term position while the downtrend runs its course. We’re not going to miss the train when the uptrend starts, and we have also mitigated some of the risks of buying in a downtrend. But keep in mind that this strategy can be risky – we’d be buying in a downtrend after all.

Dollar-Cost Averaging Calculator

You can find a neat dollar-cost averaging calculator for Bitcoin on dcabtc.com. You can specify the amount, the time horizon, the intervals, and get an idea of how different strategies would have performed over time. You’ll find that in the case of Bitcoin, which is in a sustained uptrend over the long-term, the strategy would have been consistently working quite well.

The Case Against Dollar-Cost Averaging

While dollar-cost averaging can be a lucrative strategy, it does have its skeptics as well. It undoubtedly performs best when the markets experience big swings. This makes sense, as the strategy is designed to mitigate the effects of high volatility on a position.

According to some, however, it’ll actually make investors lose out on gains when the market is performing well. If the market is in a sustained bull trend, the assumption can be made that those who invest earlier will get better results. In this case, lump sum investing may outperform dollar-cost averaging. The best way get better at markets is by doing, so whenever possible try and test our your strategies in a safe environment. On algorithmic crypto trading platform Æsir, you can actually try this all out in Paper Trading mode, and see how a DCA strategy performs in real time, without risking real funds.

Closing Thoughts

Dollar-cost averaging is a redeemed strategy for entering into a position while minimizing the effects of volatility on the investment. It involves dividing up the investment into smaller chunks and buying at regular intervals. The main benefit of using this strategy is the following: timing the market is difficult, and those who don’t wish to actively keep track of the markets can still invest this way.

However, according to some skeptics, dollar-cost averaging can make some investors lose out on gains during bull markets. With that said, losing out on some gains isn’t the end of the world – dollar-cost averaging still can be a convenient investment strategy for many, and you can easily automate it with tools such as Æsir