Dollar Cost Averaging: The Smart Strategy to Mitigate Risk During Crypto Bear Markets
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The crypto market has had a tough year, with bitcoin declining by over 69% since it reached its all-time high of $69,000 in November 2021.
Many investors are considering investing all their money to buy the dip — purchase crypto assets when they drop in price — and sell their assets when the market recovers. While this is a good strategy, it can be very risky. It is difficult to tell when a crypto asset has bottomed out or if it will still fall even more.
So how do you invest in the market while protecting your investment capital from losing even more value if the market goes further down? How do you keep some of your capital to buy even more crypto should the market crash even further? The answer is a simple but highly effective strategy called Dollar Cost Averaging.
With dollar cost averaging, you can invest small amounts of your money on cryptocurrencies at a chosen frequency (say, every week or month) so that you don’t go all-in at once and risk losing most of your capital.
This article will go through what is the meaning of DCA, how you can do it, and some of its advantages over “buying the dip.” Let's dive in.
Dollar Cost Averaging (or DCA) is a strategy used by crypto and stock market investors to spread their trading capital over a period. Investors use it to mitigate short-term and long-term volatility in the market. DCA (different from daily cost averaging) is a strategy that works well if you are interested in an asset for the long term instead of trying to get quick short-term gains.
For example, instead of choosing to invest $1200 at a time on a crypto asset (let's say, using the DCA strategy to DCA Bitcoin), you can invest $100 every month over the next 12 months. This way, you can avoid the risks that come with short-term declines and enjoy the benefits of long-term increments.
According to crypto analyst Carl B. Menger, investors who use the DCA strategy could “beat 99.99% of all investment managers and firms on planet Earth.” For this statement to be accurate, we have to believe that the cryptocurrency we’re investing in with this strategy will trend upwards in the long term.
It is important to understand that while DCA deals with the risks of negative short-term volatility, it also cancels out the gains from positive short-term growths. So, for example, if a cryptocurrency gains rapidly in a week, investors who bought the dip would make more returns than investors who used the DCA strategy.
Why Dollar Cost Averaging is a Better Strategy than Buying the Dip
Dollar cost averaging is better than buying the dip for two reasons.
First, it takes away all the emotion, time, effort, and resources spent trying to time the market like many retail traders do when buying the dip.
Over the years, there have been numerous short- and long-term analyses by professional analysts who claim to know where a coin will be at the end of a period. Unfortunately, most of them have failed terribly, not because the analysts are terrible, but because it is almost impossible to time the market perfectly.
It is difficult to know if a coin will keep going down or if it has reached the end of its dip. Also, when a coin starts rising from a dip, it’s difficult to know if it’ll keep rising. So many crazy emotions come with trying to game the market, and many investors struggle with FOMO (Fear of Missing Out) or the fear of losing their investment.
DCA is an emotionless, robotic style of investing that takes away the fears of short-term fluctuations in the price of a crypto asset you believe in for the long term.
The second reason why DCA is a better strategy than buying the dip is that it helps you acquire crypto assets at low prices when the market goes down.
If an investor times the market wrongly when trying to buy the dip, they will lose some of their investment capital. This means they would lose the opportunity to buy more cryptos at a reduced price.
On the other hand, DCA traders would still be able to acquire more crypto assets when the prices go further down.
How to Use the Dollar Cost Averaging Strategy
The DCA strategy method you use depends on your cash flow and the amount of initial investment capital you have available to you. It also depends on the market trends and if you wish to adjust your style to match the market behavior.
For example, let’s say you have $4,800 you wish to invest in Ethereum over 12 months. You can spread your entry by investing $100 weekly for the next 12 months. Unfortunately, ETH goes into a bear market, and from your in-depth analysis, you don’t expect a prolonged bull market for another 2 years.
You can decide to change the frequency of your investment to $100 every other week to take advantage of the bear market. You can acquire cryptocurrencies at low prices when the market is down and enjoy better returns when the prolonged bull market comes.
Another method of DCA investing could be investing a set percentage of your monthly income. For example, you can invest 5% of your earnings. This set percentage doesn’t change regardless of the change in your monthly income.
You can use a DCA calculator to understand how your strategy could perform over time.
How to Dollar Cost Average Bitcoin?
Let's say you want to DCA Bitcoin and have $1,000 to invest. You decide to invest $100 every week for 10 weeks. In the first week, Bitcoin is trading at $50,000, and you purchase 0.002 BTC for $100. The following week, the price of Bitcoin drops to $45,000, and you buy 0.0022 BTC for $100. By the end of the 10 weeks, you would have purchased a total of 0.021 BTC for an average cost of $47,619. This means that even if the price of Bitcoin fluctuates during this period, you still end up with an average cost per coin that is less volatile than the market price.
Another example is investing a fixed amount of money monthly. Let's say you want to invest $500 per month in Bitcoin for a year. In January, Bitcoin is trading at $30,000 per coin, and you purchase 0.0167 BTC. In February, the price of Bitcoin drops to $25,000, and you purchase 0.02 BTC. By December, you would have invested a total of $6,000 and bought a total of 0.2986 BTC. The average cost per coin for the year would be $20,101, which is lower than the market price fluctuations during the year.
Overall, dollar-cost averaging can be an effective strategy for investing in Bitcoin as it helps to reduce the impact of market volatility on your investment. By investing a fixed amount of money at regular intervals, you can build a position in Bitcoin over time, regardless of its price fluctuations.
Dollar Cost Averaging vs. Lump Sum Investing
Lump Sum Investing (LSI) is an investment method that involves putting a lot or all of your capital at once into buying crypto assets. Statistically, this method outperforms Dollar Cost Averaging in the long term, but it also has some flaws.
First, LSI requires that you have all your capital at once, ready to invest. For some people, this might be feasible, but for most people, it’s not. DCA is a better strategy than LSI in this instance because it allows for disciplined investing from people who can’t afford to invest a massive amount at once.
For people with regular income who can only spare some money for investing every month, DCA allows them to start investing on time instead of waiting to save up for LSI.
Another issue LSI has is that it comes with many emotions that can negatively impact your decisions. For example, imagine investing all your capital just before a bear market. Then, the fear of losing all your capital kicks in, and you might decide to cut your losses and exit the market at a price lower than your entry point.
On the other hand, with DCA, even if your investment horizon changes due to unforeseen circumstances, you can always adjust and take advantage of the market.
The most optimal investment involves a mixture of DCA and LSI. If you have a considerable amount of capital, you can choose to invest a part of it (say half) at once. Then, you can invest the second part of the capital in bits using the Dollar Cost Averaging strategy.
This way, you enjoy the long-term benefits of lump sum investing and still have the capital to take advantage of when the market is down. This idea comes from Larry Swedroe, a stock market analyst and chief research officer for Buckingham Wealth Partners. According to him, this strategy helps tackle both the logical and emotional issues of both methods and helps the investor win from a psychological perspective.
Now you know the meaning of DCA in crypto. Sure thing, it certainly has some flaws, but it beats every dip buying strategy every time. Furthermore, DCA can beat almost all crypto investing strategies when used with lump sum investing.
If you don’t have a lump sum to start investing, then DCA is your best bet. Remember, it is always better to enter the crypto market one step at a time instead of waiting to put all your money together and go all in at once.
You can start investing in the crypto market with zero fees using the DCA strategy on the Lykke exchange. All you have to do is go through the KYC procedure to get verified, then deposit funds into your wallet using the fiat gateway at zero banking fees. Once that is settled, you can start trading on the exchange with zero fees!
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About Lykke, the Zero-fee Crypto Exchange
Lykke is a crypto exchange headquatered in Switzerland. It offers free crypto trading for all users of the exchange. There are more than 20 selected cryptocurrencies on the platform, and you can trade them with no fees.