Averaging is a method of managing the purchase price of an asset by increasing or decreasing its average cost. It is often applied when an asset has been purchased at different prices, and it is necessary to determine the price at which it is more profitable to sell to achieve profit or minimize losses. Let's see how this works in practice and which mathematical formulas can help in making a selling decision.
What is averaging?
In the world of crypto trading, averaging is the process of buying or selling an asset at different price levels to 'smooth out' the initial cost. For example, if an asset was initially purchased at a price that later decreased, a trader can buy more tokens at a low price, which will reduce the average cost of the asset. As a result, it is not necessary to wait for the price to recover to the original level to achieve profit.
Example of averaging and calculation of average cost
Suppose you bought 1 BTC for $65,000, and then, after the price drop, decided to purchase another 1 BTC for $58,000. To calculate the average price, we will use the formula:
Average price = Cost of the first purchase + Cost of the second purchase \ total volume
First purchase: 1 BTC for $65,000.
Second purchase: 1 BTC for $58,000.
Total volume: 1 BTC + 1 BTC = 2 BTC
Then the average price:
65,000 + 58,000 2 = 123,000 /2 = 61,500
Thus, your average purchase level is $61,500 for 1 BTC. Now, to achieve profit, the price must rise above this average cost.
It is important to consider all volumes when calculating averaging!
When to sell: calculating the breakeven and profit levels
For breakeven: if the goal is to break even, it is enough to wait until the asset price reaches or slightly exceeds the average purchase price. In our example, this is $61,500 for BTC.
For profit: here you need to determine the desired percentage of profit. Let's say you want to achieve a 10% return. The formula for calculating the selling price will be:
For example, a 10% increase:
61,500 × 1.10 = 67,650
Thus, selling at $67,500 for BTC will ensure a 10% profit on the invested funds.
Application of averaging in a volatile market
Averaging makes sense in cases where the asset shows significant fluctuations, and you are confident in its recovery. This can be justified in the volatile cryptocurrency market, where assets, often declining in price, can recover quickly. However, if the asset shows a long-term negative trend, the averaging strategy may lead to accumulating assets with decreasing value, which increases risks.
Risks and limitations of the averaging strategy
Although averaging can be a useful tool, it is important to consider the following points:
Long-term negative trend: if the asset continues to decline, averaging will lead to an accumulation of losses.
Lack of liquidity: it is important to have reserve funds for averaging to avoid running out of money during price drops.
Psychological barrier: sometimes averaging can be a psychologically difficult decision, as it requires further investments in a losing asset.
Averaging is a useful strategy if applied consciously and with clear calculation. It's critically important to monitor the total amount of investments and have a plan in case the asset price does not return to the desired level.
