Table of contents
Introduction
What is dollar-cost averaging?
Why use dollar-cost averaging?
Dollar Cost Averaging Example
Dollar Cost Averaging Calculator
Opposition to Dollar-Cost Averaging
Summarize
Introduction
Active trading is time-consuming and laborious, and the returns may not be satisfactory, but there are other investment options. Perhaps you are like many investors, looking for a less difficult, time-saving and labor-saving investment strategy, or a more passive investment method. The Binance ecosystem provides users with many options, including staking, depositing assets in Binance Treasures, and joining the Binance Mining Pool.
Do you want to invest in the market but don't know where to start? What's the best way to build a long-term position? In this article, we'll discuss an investment strategy called dollar-cost averaging (DCA). This strategy can easily reduce some of the risk of opening a position.
What is Dollar Cost Averaging?
Dollar-dollar averaging is an investment strategy designed to hedge against the effects of volatility on asset purchases. The specific method is to buy equal amounts of assets regularly.
By entering the market this way, the investment is not as susceptible to volatility as a lump sum (i.e. a single payment). Why is this? Buying at regular intervals allows the average price to level out. In the long run, this strategy reduces the negative impact of poor timing on the investment. Next, we'll explain how dollar-cost averaging works and why it's recommended.
Why use dollar-cost averaging?
The main benefit of dollar-cost averaging is that it reduces the risk of poorly timed purchases. One of the biggest challenges in trading or investing is timing your entry into the market. Even if you are in the right direction, if the timing is wrong, the entire trade will usually fail. Dollar-cost averaging can effectively mitigate this risk.
Compared with investing a large sum at once, investing the same amount of money in smaller portions may yield better results. Buying at the wrong time happens all the time and can lead to poor investment results. In addition, applying dollar-cost averaging can eliminate some of the bias in investment decisions and make the decision for you directly.
Of course, dollar-cost averaging cannot completely avoid risks. It can only help traders enter the market smoothly and minimize the risk of bad timing. Dollar-cost averaging is by no means a guarantee of successful investing. After all, there are other factors to consider.
As mentioned in the previous discussion, choosing the right time to enter the market is a big problem. Even experienced traders find it difficult to accurately judge good opportunities to enter the market. Therefore, after opening a position using the dollar-cost averaging method, don't forget to formulate a selling plan, that is, a trading strategy for closing the position.
If you already have a target price (or price range), it's pretty simple. You can divide your investment into smaller equal amounts and start selling once you get close to your target price. This effectively mitigates the risk of a poorly timed sale. Of course, the specific operation method completely depends on the individual's trading system.
Some people adopt a "buy and hold" strategy, with the basic goal of never selling, believing that the assets they purchase will continue to appreciate over time. The following chart shows the performance trend of the Dow Jones Industrial Average in the last century.
Performance of the Dow Jones Industrial Average (DJIA) since 1915.
The index has been trending upward despite brief recessions. The goal of a buy-and-hold strategy is to enter the market and remain in the position long enough that the timing of entry becomes irrelevant.
However, it is worth noting that this strategy is usually more suitable for the stock market, not necessarily for the cryptocurrency market. Don’t forget that the performance of the Dow Jones Industrial Average is closely related to the real-world economic situation, while other asset classes are completely different.
Average cost average example
Let us understand this strategy with the following example. Suppose we have a fixed capital of $10,000 and believe that investing in Bitcoin is a wise move. We predict that the price will fluctuate within the current range, so using the average cost method strategy to gradually open positions will achieve good results.
We divide $10,000 into 100 equal parts of $100. We buy $100 worth of Bitcoin regardless of the daily price movement. In this way, the time to enter the market can be spread out over a time span of about three months.
Now, let’s take a different approach and see how we can use dollar-cost averaging flexibly. Assuming that Bitcoin has just entered a bear market, we predict that there will be no long-term bull market in the next two years, but we are also sure that a bull market will appear sooner or later, so we want to prepare for a rainy day.
Should we still follow the above strategy? Maybe change it. Because the time horizon of this portfolio will be longer. We must be mentally prepared to allocate this $10,000 capital according to this strategy for the next few years. So what should we do?
We again divide the investment into 100 $100 portions, but this time choose to buy $100 worth of Bitcoin each week. There are approximately 52 weeks in a year, so the entire strategy will be executed in two years.
In this way, we take a long position in a market that continues to trend down. We don't miss out on a recovery, but we mitigate some of the risk of buying into a downtrend.
However, don't forget that this strategy still carries risks since the market is in a downtrend. For some investors, it may be better to wait until the downtrend is clearly over before getting back in. If you choose to wait, your average cost (or price per share) may increase, but much of the downside risk will be mitigated.
Average cost calculator
A simplified version of the Bitcoin Dollar Cost Averaging Calculator is available at dcabtc.com. By selecting the amount, time span and time interval, you can understand the performance of different strategies within the set period. In the case of Bitcoin, this strategy has been working well because of its long-term upward momentum.
Assuming that you only bought $10 worth of Bitcoin per week over the past five years, here is a detailed investment performance. $10 per week may not seem like much, but as of April 2020, your cumulative total investment would be around $2,600, and your Bitcoin holdings would be worth about $20,000.
The weekly price trend of buying $10 in Bitcoin over the past five years. Source: dcabtc.com
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Opposition to Dollar-Cost Averaging
While dollar-cost averaging is a profitable strategy, some are skeptical. Dollar-dollar averaging undoubtedly works best when markets are volatile. This makes sense, as it is a strategy specifically tailored to mitigate the impact of high volatility on positions.
But some people believe that this strategy will actually reduce investors' returns when the market is doing well. Why? If the market continues to be in a bull market, it can be inferred that the income of early investors will be more substantial. In this way, dollar-cost averaging suppresses earnings growth in an upward market trend, and in this case, the performance of a one-time investment may actually be better than dollar-cost averaging.
However, most investors do not have large amounts of money to invest in one-time investments and can only make small long-term investments. In this case, dollar-cost averaging is still the appropriate strategy.
Summarize
Dollar cost averaging is a redemption strategy that minimizes the impact of volatility on investments while opening positions normally. Its main method is to "break the investment into small pieces" and buy them regularly.
The main advantage of this strategy is that it can get rid of the problem of "timing the market" and is suitable for investors who do not want to watch the market.
Some skeptics, however, argue that dollar-cost averaging can reduce returns for some investors during bull markets. That said, a slight reduction in returns is not a big deal, and dollar-cost averaging remains a convenient investment strategy for many people.
