19 August 2022 • 6 min read
The crypto market is notoriously volatile and can cause a great deal of anxiety for investors as a result. How do you know the best time to buy cryptocurrency in a market that’s constantly fluctuating? Should you buy crypto low or high? Should you buy the dip? Should you sell and cut your losses? There are a myriad of questions to consider when investing in crypto, and these uncertainties are only magnified by your emotions and an underlying fear of missing out (FOMO).
As with any other endeavor (investing or otherwise), it is imperative to have a plan from the outset. However, most crypto enthusiasts start investing in cryptocurrencies without an investment strategy, preferring instead to use an ad hoc approach that tries to time the market for that perfect time to buy (or sell). The only problem is that this is a fast track to losing your money. Even seasoned day traders can struggle to predict the best trade entries and exits, which is why the most successful ones rely on automated crypto trading.
Despite the many investor uncertainties and anxieties, the good news is that you can reduce the impact of the market and become less susceptible to fluctuations by sticking to a strategy. While there are several investment strategies, many crypto investors are beginning to see benefits from one in particular, dollar-cost averaging (DCA).
Dollar-cost averaging (DCA), sometimes referred to as the constant dollar plan, involves regularly investing the total amount of money in smaller increments on a particular asset over time regardless of price, rather than investing one lump sum all at once. For example, instead of investing $1200 in Ethereum, you can invest $100 monthly for the next twelve months by using DCA.
The obvious benefit is that it helps to reduce the negative impact on an investment caused by short-term volatility. By using the DCA strategy, you can take advantage of market fluctuations by lowering their average cost per asset without risking too much capital at any point in time.
The expectation with the constant dollar plan is that the price of an asset such as a cryptocurrency will increase in value in the long term. By buying incrementally and consistently, you invest when the price is high or low, and each purchase results in an average purchase price that should be lower than lump sum investing.
There are essentially two main types of crypto investors, active traders and HODLers, and both have different behavioral approaches to investing. By holding an asset for short-term gain, traders can define the level of risk and use a stop loss when losing. On the other hand, HODlers adopt the buy and hold principle and invest their crypto for the long haul, typically for years.
According to American billionaire Charlie Munger, the real money comes not from buying or selling but from waiting, a philosophy that holds true in the crypto market. While a crypto trader takes advantage of market volatility, an investor looks for the best buying opportunity with a view to the long-term benefits.
For decades, investors have been using the DCA strategy to weather volatility in the stock market, but the question remains: Is DCA a good strategy to use in crypto? The “buy the dip” mantra still persists in crypto and the approach is not without its merits. However, how can you be sure that you’re buying into the bottom of the dip or, even worse, the bottom of a market crash? What’s to say that BTC (for example) won’t dip even lower after you’ve invested? Trying to time the market with this sort of guesswork (whether educated or otherwise) rarely ends well. A safer plan for building wealth over a longer period of time is dollar-cost averaging.
A time-tested strategy, dollar-cost averaging confers many benefits to traders. It will make you a more disciplined, efficient investor, and it may even spare you the gray hair from stressing over identifying the best trade entries and exits. Below are some of the main advantages of dollar-cost averaging.
A dollar-cost averaging strategy minimizes investment risk by preserving the capital, especially during a market crash. In addition, it avoids the lump sum purchase of security during an artificially inflated market situation. DCA minimizes the short-term feeling of regret during a sharp price decline and can also boost long-term returns.
When it comes to investing, good timing matters a lot, but even experts find it difficult to predict market swings. In fact, it’s virtually impossible for experts to time the market perfectly. If you invest a lump sum at once in a particular cryptocurrency, chances are that you stand to risk more if the timing of the investment happens at the start of a market downturn. No one can precisely determine the market’s bottom; hence, the dollar-cost averaging strategy can smooth market timing and prevent the pitfall of buying only when the price is rising.
Investing automatically with the DCA strategy reduces emotional-based decisions and prevents you from damaging your investment portfolio. You’ve established a preset course of consistently investing a certain amount in your preferred asset irrespective of the market conditions. By doing so, you can acquire more of your preferred investments at a lower cost without the emotional rollercoaster of finding the perfect time to buy or sell.
DCA will make you a disciplined investor. By investing a certain amount each and every month, the investment process becomes habitual. You are no longer guided by market hype or news cycles, but take a slow-and-steady approach. You have an investment plan and you’re sticking to it, which is an effective way to build wealth over time.
Despite its many benefits, DCA can potentially have a few drawbacks and it’s important to be aware of them.
So you’ve decided to invest incrementally over a longer period of time, right? One problem is that you’re opening yourself up to cash drag. You’re leaving yourself in cash longer than if you had made a lump-sum investment. That extra cash hanging around is not working for you. It may even be working against you because of inflation.
Historically, markets tend to be bullish. Consequently, you may miss out on healthy returns during a rising market by prolonging the investment process over a longer period of time. In other words, smaller amounts invested periodically cannot maximize returns during a rising market in the same way that a lump-sum approach can. Some studies have even suggested that DCA can provide lower average returns over a longer period of time than lump-sum investing.
Since there is a fee for each transaction, you run the risk of incurring more transaction fees with a dollar-cost averaging strategy, which can reduce the gains accrued in the portfolio. However, DCA is a long-term strategy, and the transaction fees should be minimal when compared to your potential long-term gains.
According to Vanguard, the US-based investment management company, about 66% of a lump sum investment is most likely to produce higher returns than DCA. And the answer is obvious: the higher the risk, the higher the returns (and vice versa). This is a general principle in the theory of risk and returns. By following a DCA strategy to reduce risk, an investor is most likely to lose out on greater gains than someone that invests in a lump sum.
DCA critics will occasionally point out that market conditions change all the time and investors should be flexible enough to take advantage of these changes. Whereas some see investor discipline with DCA, others see rigidity, especially when it comes to asset allocation and an inability to realize gains from new opportunities. Because of the strict scheduling in place with a DCA approach, investors can find it difficult to change things on the fly to leverage changing market conditions.
Investing with dollar-cost averaging is similar to setting up a recurring order on a cryptocurrency exchange. The volatility of cryptocurrencies can be fairly high, frequently surpassing that of stocks, making the issue of whether to trade stocks or crypto an additional consideration to weigh as an investor.
Nevertheless, there is general agreement that DCA is a safer general investing strategy than lump-sum purchasing and selling. Although there is less danger and therefore less potential for a sizable reward, there is still an opportunity to profit from market fluctuations in a way that doesn’t compromise your portfolio or long-term goals. However, holding digital assets can be risky business, particularly during market swings, but there the current crypto winter is still seen as a buyer’s market by many.
Whether copy trading, arbitrage, HODLing, or DCA, there are many ways to trade crypto. The most important thing to remember is to do your homework, read widely to better understand how crypto trading works, harness the power of automated trading, and never risk more than you can afford to lose.