Are you still buying the dip or already dollar-cost averaging?
If you’re a trader like me, then you have an incredible talent to buy assets before a major dip or sell them long before they reach their all-time highs. And whenever we find ourselves in another crash, next to reading tweets recommending to buy the f*cking dip, you might find others that use the acronym DCA to give their famous, not financial advice.
Why’s that, and what’s DCA anyway?
DCA is an acronym for Dollar Cost Averaging and describes a way of investing. If you get started investing in any asset, be it crypto or stocks, you could go ahead and start investing one lump sum.
This can work out well but makes you very dependant on timing. Investing a huge sum at the wrong time can result in big losses. Especially with volatile assets like Bitcoin, sorry to the new market entrants who bought at $68,000 and have seen their investment halved in value since.
Dollar-Cost Averaging can help to minimize the impact of timing and volatility on your investment. It’s a pretty straightforward strategy that consists of splitting a larger sum to invest into smaller amounts and investing those over time.
When dollar-cost averaging, you lower the overall average cost of the investment. The traders who bought Bitcoin at $68,000 can lower their average buy price if they buy some more during the dip (this isn’t financial advice, just an idea for when you believe in the asset class and have done your research). 😉
Let’s do some math. You invested $100,000 in Bitcoin when it was trading at $50,000. Unfortunately, now Bitcoin is trading at $25,000 and measured in dollars, is just half worth what you put in. First of all, take a deep breath. We’ve all been there. It can be quite intimidating at first, but hopefully, you entered crypto with the awareness that volatility doesn’t always work in your favour.
If you are dollar-cost averaging and $100,000 were just the first chunk of your investment, you could now use another $100,000 to buy Bitcoin. While for your first 100,000 investment, you received 2 BTC, you now get 4 BTC for the next $100,000.
And now, when calculating the average price you entered the position, it’ll be significantly lower. In total, you’ve invested $200,000.
Initially, your entry price was $50,000. Yet by adding more Bitcoin at a lower price, you effectively lowered your average entry price. Below is how to calculate your average entry price. You add up all your previous buys and then divide them by the number of BTC (or any other asset) you now hold.
The math isn’t too hard to grasp, and dollar-cost averaging offers various benefits:
- Risk reduction: DCA preserves money and helps avoid investing at an awful time. Throughout prolonged downturns, it can ensure minimum loss and reduce feelings of regret. And if you stock up during a downturn, how great is your portfolio going to look throughout the next boom?
- Lower cost: as seen in the example above, you get “more” for your money when buying at lower prices. By stretching out purchases over time, chances are you can manage your average entry price better and break-even faster.
- Manage emotions: If you’re the type susceptible to FOMO and feeling left-out throughout bull markets, then DCA can help manage emotions. Since you decide on a rational basis how much you will invest and at what intervals/price points, you don’t only feel in control but are also less likely to fall prey to FUD or FOMO.
However note, DCA isn’t a perfect strategy either. It might be a bit more complicated to keep track of assets and can minimize the return you make since you might not see the quick gains as someone who got lucky and invested a lump sum.
At the end of the day, every trader will have to find out which strategies work best for them. In conjunction with other portfolio management strategies such as diversifying and rebalancing, Dollar-Cost Averaging can greatly improve your chances of success and potentially your emotional well-being.
TLDR: Dollar-Cost Averaging is an investment strategy whereby instead of investing a lump sum, investors invest smaller quantities at frequent intervals. This helps manage the average entry price and reduces the impact of timing and volatility.
Now, just one question is left: Are you still relying on dips to buy or already dollar-cost averaging? Of course, nothing is wrong with combining the two. Either way, Happy Trading!