People can invest in cryptocurrencies using various strategies. However, the rate of return is not always the same and the risks involved are different. Maybe the most common trading strategy is to buy the dip. This occurs when investors buy a cryptocurrency when the market price is very low and sell it when the price has risen beyond a certain point. However, another interesting strategy is the Dollar Cost Averaging (DCA).
Dollar cost averaging
This strategy involves an investor incrementally making an investment in a certain cryptocurrency. The individual does this in order to take advantage of changes in prices over a long period, thereby reducing the risks involved. For example, a person who aims to invest $1 000 in bitcoin would buy BTC worth $100 per week for ten weeks. This means he/she buys bitcoin when it is at different price levels.
For example, the price of BTC in the first week would be $29 000, $30 000 in the second week, $33 000 in the third week, $45 000 in the fifth week and so on. This does not imply that the price would continue rising. Maybe, the price of BTC in the seventh and eighth weeks could drop to $31 000 and $28 000 respectively.
As we note, the main idea of this strategy is to buy an asset at a different price range rather than buying them all at once. Therefore it offsets the volatility of cryptocurrencies over the period under consideration.
How the strategy works
There are several steps an investor should take in executing the Dollar Cost averaging strategy.
First, the crypto investor should select a suitable cryptocurrency which may have a steady price increase in the future. It is best to choose a coin or token which has strong fundamentals. For instance, bitcoin could be a very suitable cryptocurrency for that investment purpose. This is because it has a finite supply of 21 million coins, unlike other tokens whose supply may continue to rise.
Unfortunately, this strategy is not suitable for any type of coin or token. The reason is that some prices of tokens may nosedive and never rise again. We have witnessed such cryptocurrencies in the past, which in the end disappeared from the market.
The second essential step is to set aside a certain amount of funds for investment in the chosen cryptocurrency. In this case, we assume that an investor sets aside $50 000 to invest in a coin of choice.
Specifically, the strategy involves setting aside monthly investment instalments rather than investing the amount all at once. For example, the investor may plan to buy the cryptocurrency worth $2 000 per month. This translates to investing the amount over 25 months. Whether the price rises or falls, the individual is committed to investing the predetermined amount within a specified period.
What are the advantages of using the Dollar Cost Averaging investment strategy?
There are several key benefits from using this strategy.
Since you do not invest a large sum of money in a cryptocurrency all at once, you become less emotional when its price falls significantly. Instead, you remain confident that one day its price will rise again. After all, the strategy is suitable for long term investment.
Many exchanges allow users to link their credit cards or bank accounts, enabling them to purchase cryptocurrencies using these methods. This facility also makes it possible for people to set recurring purchases of coins or tokens at predetermined dates. As a result, you can buy your chosen coin at a specific date such as the last day of every month. In the end, this is very convenient as the purchase of the cryptocurrency is automated.
Drawbacks of the Dollar cost averaging strategy
The main disadvantage is the transaction fee the investor incurs when he purchases some cryptocurrencies from certain exchanges. However, since the strategy is a long term one the transaction cost usually becomes negligible.
Secondly, there is a possibility that you lose out when investing in batches rather than all at once. This is particularly so, if you compare the strategy against other investment opportunities such as yield farming and liquidity provision.
The dollar cost averaging strategy is unique in that it has low risk. Since it is a long term strategy the investment is not affected by short term dips in prices of the cryptocurrency.