Dollar Cost Averaging: What it is and Why You Should Do It

Key Takeaways

• Dollar-cost averaging makes it easier for traders to deal with uncertain markets by making purchases automatic.
• Dollar-cost averaging involves investing the same amount of money into a certain cryptocurrency at regular intervals over a certain period of time, regardless of price.
• By using dollar-cost averaging, investors may lower their average cost per share and reduce the impact of volatility on their portfolios.

Overview

It is obvious that cryptocurrency is a volatile asset class, and major tokens can fluctuate drastically over the course of even a single day. Certain market conditions and even macroeconomic factors can lead to substantial price movement in assets and make it difficult for investors to determine the optimal time to enter or exit their investment. Often new investors will try to time the market, leading to higher-than-necessary price entrances and lower-than-expected price exits. Such market conditions can often manipulate an investor's emotions into making irrational decisions, and therefore it is important that you deploy a well-thought-out plan when making trades. This is where dollar cost averaging can be very helpful.

How It Works

An investor can employ the straightforward strategy of dollar-cost averaging to accumulate savings and wealth over time. Additionally, it gives investors a means to disregard recent market volatility. Investing a set dollar amount on a regular basis, independent of the share price, is known as dollar-cost averaging. It's an excellent method to form a disciplined investing habit, increase your investment efficiency, and possibly reduce your stress and expenses.

Let's say you invest $100 every month into a cryptocurrency. When the market is up, your $100 will buy fewer tokens, but when the market is down, your money will buy more. Over time, this strategy could lower your average cost, compared to what you would have paid if you'd bought all your shares at once when they were more expensive than the average.

Dollar-cost averaging may also help prevent your emotions from undermining your portfolio. When you invest a large sum of money in a single trade you're more likely to feel regret if that trade turns out to be poorly timed. The majority of people are naturally loss-averse, according to behavioral economists, and they typically respond more strongly to losses (or the possibility of losses) than to profits. However, dollar cost averaging allows you to invest smaller amounts of money over time, which makes it simpler to manage an investment made at the wrong moment.

Potential Negatives

Although dollar cost averaging may help you make more calculated entries and exits into different cryptocurrencies, it may not always give you the best entry or exit. In the case of a token that is in a consistent uptrend, dollar cost averaging would give you a worse entry price than buying your entire position on the very first day. Similarly, dollar cost averaging into a token that is in a steady decline will also be detrimental, as you will get less money for your tokens than having sold it all on the first day. Therefore, it is important for traders to realize that DCA may not always be the best choice for them, and maybe deploying some technical analysis skills would be more beneficial. You can learn more about technical analysis here.

Conclusion

Dollar cost averaging (DCA) is a well-known investment strategy that helps traders to carry out a calculated approach to their entries and exits. It allows traders to average out the volatility of cryptocurrency markets over a specific time period of their choice, and maintain a level head during times of increased market swings.

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