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Dollar Cost Averaging

September 22, 2022

Dollar cost averaging (DCA) isn’t specific to crypto markets, nor does it have its origins there. However, although not originally intended for crypto, it is an investment strategy that is ideally suited to cryptocurrencies, particularly for those quite new to the game and/or those investing based on the long-term prospects for crypto and blockchain technologies.

What Is DCA?

Dollar cost averaging has its roots in a strategy employed by institutional investors that, like so much in that field, was probably created originally to minimize the risk of individuals or corporations being criticized or even sued for making a bad decision. The decision to invest in a particular security, a stock or bond, say, is obviously one that can easily be criticized with hindsight. But so is the timing of that investment, the decision about when to invest in it and at what price. The basic idea is that rather than decide on an entry price that might look foolish a few weeks or months later, you divide your money into a number of equal payments, and invest over time on a regular, pre-set schedule.

What started as a blame-avoiding strategy for fund managers, though, has become an accepted strategy for individual investors who have limited funds to invest.

How it Works

Let’s say that you buy stock ABC today at $100 and it drops to $80 by next month, you not only have a short-term loss on in your portfolio, but even if the stock bounces back to above their entry point there is also an opportunity cost to your decision. To understand that, think about what it means six months later if, say, the stock has risen to $200. If you bought at $100, you have a 100% gain, but if you had waited until it was $80, you would have a 150% profit on your books. That can leave you frustrated, even after a good investment.

DCA takes that risk out of the equation. If the investment were split into ten weekly purchases, you would have bought some at $100, then bought at lower levels on the way down, including some at or near the $80 low, then at various prices on the way up too. The net result could well end up being an average purchase price of close to the original $100 level, but you aren’t left with the feeling that you bought at the “wrong” time.

Taking Emotion out of Investing

With DCA, there is no “wrong” time to buy. Take ether, for example…

Maybe you had $10,000 to invest on November 7th last year and bought ether at 4,600 because logical analysis told you that blockchains were the future of finance and record-keeping. Then logic would also tell you that the Ethereum ecosystem, and therefore demand for ether, would grow for decades, and hat would push the price in dollar terms ever higher over time. As I said, a sound, logical view. Then the price started to fall. At some point, you felt you had to get out of that position and many would have sold, maybe at 2,000 or, even worse, right around the bottom at 1,000.

In that situation, your emotions told you to get out; fear and panic took over. However, logically, nothing has changed. Ethereum still has utility in blockchains, and blockchain use is still growing rapidly.

If, however, instead of laying out $10,000 all at once you had split your money and invested $1,000 a month for ten months, here’s how your purchases would have looked…

In this example, dollar cost averaging obviously resulted in a better entry level, but it had another advantage, too. Your view of what you did changes from “I bought at the wrong time” to “I bought some at the bottom!”. Far from being squeezed out around $1000, you were buying there, at a biog discount to the price when you first decided to buy.

Suitability to Crypto

Basically, DCA, is a way to smooth out the impact of short-term volatility on a long-term investment and take emotions out of trading decision. That makes it particularly suited to individual investors in the crypto world.

Cryptocurrencies are a new phenomenon and the markets in them are therefore somewhat immature, and often without a great deal of liquidity. That makes market moves, that are often based on anything but long-term logic, unpredictable. For some traders, that is a feature, not a bug, but to most long-term investors, it is a nuisance. Sure, if you believe that crypto and blockchain technology are the future of finance, you shouldn’t care about short-term volatility, but you are human and so can’t avoid the emotions that come with losing money, even if it is only on paper.

Volatility also makes it tempting to attempt to time the market and try to buy on dips. The problem, though, is that we can never don’t know how big a dip it will be.

After BTC’s strong run up to over 67k in November of 2021, it dropped dramatically, but then steadied early in 2022 at around 40k. Was that the time to buy the dip? Obviously not with hindsight, as we are now around 20k, but to a lot of people it felt like it at the time. If, at that time, you “bought the dip” you would be losing money. However, had you had started to dollar cost average into a purchase at 40k, you would still be “buying the dip” now at around 20k.

Using a DCA strategy to buy crypto means that you always have something to make you feel good about your decisions. If the price rises, you can pat yourself on the back for buying some at the bottom, and if it falls, you are happy because you can now buy some at a discount. You feel better about your decision either way and, as much as some people try to deny it, your feelings as an investor actually do matter. Acknowledging and managing them helps you to avoid mistakes. Institutional and desk traders joke that you know a drop has ended when the little guys start selling…don’t be the butt of that joke.

Investing vs Trading

There is one important thing to understand about dollar cost averaging in a crypto context, though. It is a great investing strategy but it isn’t suited to short-term trading. If a trader decides to buy at a particular price, it is because they believe that short-term market conditions make it likely that the thing they buy will go up. If it doesn’t, they were wrong, and buying more after a drop simply compounds their mistake. I worked for decades in dealing rooms around the world and survived that long in that job in part because of some advice from my first manager, who told me that in intraday trading, only losers average losers.

If you buy something as a trade, expecting a short-term pop in price that doesn’t materialize, the best way to manage your emotions then is simply to cut your position and think again, not to give yourself an even bigger emotional stake by buying more. Intentional averaging is a viable strategy for traders, too, but it is quite complex, nuanced one that has to be intentional to be effective. As a trader, you should never buy more in the belief that you are right and everybody else is wrong. That may even be true, but if they in their ignorance are all selling, it is going down, no matter what. That is why traders are fond of saying that the market can stay illogical a lot longer than you can stay solvent.

In the long-term, however, price always reverts to its logical level, based on fundamental considerations.

Conclusions

Assuming that you are an investor rather than a trader though, whether you are buying ETH, BTC, or SmartFi’s loan utility token, SMTF, you are buying with a long-term view. When that is the case, particularly in a volatile market, dollar cost averaging, as a strategy planned in advance, gives you a lot of advantages. It makes each individual investment a manageable amount for you, smooths out market volatility, and avoids the emotional rollercoaster that often comes with managing a position. Those are all reasons why it should understand DCA, and why it should be your go-to approach to a long-term investment in crypto.

Author: Martin Tillier
Martin has around forty years of market experience and, in addition to his role as Head of Research at SmartFi, is a daily contributor of market analysis and opinion to Nasdaq.com. He first became interested in crypto 2014, when he started writing regularly on the subject. He is from England but now lives in Connecticut, USA with his wife, his dogs, and his three kids’ college tuition bills. 
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