In order to better understand how DCA works in Crypto, let’s make a simple analogy.
Let’s imagine that you want to make apricot compote. You can buy 10 pounds of apricots for $1,000, all at once, meaning 1 pound is worth $100.
Or you could buy them in retail. At the beginning of every month, you buy a pound of apricots, but prices vary, meaning sometimes 1 pound is worth $110, other times, it is worth $90.
In the end, using the lump sum version, you would have gotten 10 pounds of apricots for $1,000, but using the DCA strategy, you may end up with 10 pounds and seven ounces for the same amount of money, because of the changes in price.
This is basically what DCA is all about, so stay with me up to the very end of this video, because I am going to explain what advantages this strategy has to offer.
What Is Dollar-Cost Averaging
The DCA, for short, is an investment strategy which has the goal of reducing to a minimum the impact of volatility. It is also known as Unit Cost Averaging, Incremental Averaging, or Cost Average Effect.
In DCA, instead of making one single transaction, the investment is divided into smaller amounts which are invested at regular intervals.
DCA tries to minimize the risks associated with volatility by lowering the general average cost of an investment.
How DCA Works
Let’s say you wanted to invest $500 in DOT across a five months period between June and October, 2021, meaning $100 every month.
The prices of DOT for each of those months were $27.01, $16.86, $31.47, $37.38, and $44.88.
With this money, you could have purchased 3.70 DOT in the first month, June, followed by 5.93, 3.17, 2.67, and finally 2.22 DOT in October.
After these five months, you have a total of 17.69 DOT.
In November, the price of 1 DOT stood at $53.88. This means that the profit you could have registered was $453.13 above your initial investment.
But, if you had invested all $500 at once, in October, you would have had 11.14 DOT.
That means that in November, when the price of 1 DOT was $53.88, your fiat equivalent of that would be 600 dollars, with only $100 above your initial investment.
Naturally, it goes without saying that this strategy doesn’t always lead to profit or can it always offer you protection when the prices of crypto are falling.
One of the opposing strategies of this is timing the market in which you try to predict the performance of an asset, which makes it an active strategy.
DCA, on the other hand, is a passive strategy because you don’t have to follow the market trends and you invest the same amount of money on a regular basis.
The benefits of DCA
DCA comes with several benefits, such as the fact that it reduces investment risk and capital is used to avoid a market crash. It preserves money so there will be liquidity and flexibility when it comes to managing an investment portfolio.
Purchasing market securities when the price is falling makes sure that an investor will receive higher returns. The DCA strategy basically lets you purchase more crypto than if you had bought when prices were high.
The DCA strategy also means that you invest smaller amounts, periodically, in declining markets and your portfolio will maintain a healthy balance thus leaving the upside potential of your portfolio to grow in the long term.
Furthermore, because nobody can really predict the way the crypto market swings, the DCA strategy allows for a smoothening of the cost of purchase, which is to your advantage.
DCA represents a practice in which an investor allocates an established amount of money at regular intervals for a period of less than one year – generally. The strategy tends to work best when it comes to volatile investments like crypto is.
DCA is seen as a good strategy for investors with lower risk tolerance because the lump sum strategy could mean that they may make a purchase outside the peak price.
Value averaging focuses on investing more when the price of crypto falls and less when the price is increasing.