What is Dollar Cost Averaging (DCA)?

Introduction

How to choose the right time to buy and sell has always been a challenge for all traders in the crypto market. In the highly volatile crypto market, finding the exact price to buy in is as hard as finding a needle in a haystack. Without a good trading strategy, investors may easily suffer losses in bull and bear markets.Dollar Cost Averaging (DCA) is an investment strategy that helps investors deal with uncertain markets. The strategy refers to investing the same amount of money in a target security at regular intervals over a certain period of time. It works by making purchases automatic. You buy more shares of an investment when the share price is low and fewer shares when the share price is high, so as to reduce the average cost of your investment.

What are the advantages of DCA?

Before the emergence of cryptocurrencies, DCA strategies were commonly used in the traditional financial field and are favored by many professional investment managers. Its advantages can be stated as follows:

1. No need to look for the accurate investment timing, because if you are optimistic about the long-term potential of the underlying asset, you can buy in at any time.
2. With a small amount to buy in each time, investors are less economically stressed and can easily keep on investing.
3. It’s easy for investors to make a plan in advance, so as to avoid temporary fund shortage.
4. The principle is so simple that even starters can easily get started with it.
5. In a falling market, buying in batches can diversify the risk and protect investors from getting their large amount of capital locked, and will not miss buying at a low price point.
6. Help investors to develop good discipline and the habit of making savings.
7. Keep investors away from market turmoil and psychological pressure. Instead, it will help investors spend time on other areas.
8. Generally, financial markets are growing over time, and investors who make long-term purchases and hold blue-chip assets can gain considerable returns.

The Principle of DCA

Why is DCA often regarded as a rather simple investment strategy? In fact, it is not a shortcut to get rich. It just helps investors to lower the entry threshold and deal with investment risks. It is necessary for investors to match it with good underlying assets to make long-term profits.

Let’s look at an example.

The following K-lines are the price trend of asset A and asset B respectively, and the 30-day moving average is additionally marked, which is represented by a blue line. As time passes, we can see that the price of asset A first rose rapidly and then began a long decline. Although the price of asset B fluctuated violently, it maintained a slow upward trend for a long time.

Source: TradingView- the price trend of asset A

Source: TradingView-the price trend of asset B
The moving average has a special meaning in the DCA. Mathematically, it can be proved that the moving average is the cost line of the DCA. If an investor has purchased the same asset using a fixed amount every day in the past 30 days, the holding cost is the value of the 30-day moving average. For asset A, it showed a good performance in the initial stage. However, if there is no immediate sell-off to stop the deduction, the subsequent slow decline will only result in losses due to the continuous amortized cost. If the investor decides to invest in asset B, which starts with a wide fluctuation, the long-term upward trend will allow the holder’s assets to grow steadily without much management.
It can also be seen from the above chart that the DCA plays a role in coping with the risks. In the event of drastic price fluctuations, what DCA does is just gradually make adjustments according to the trend, and the investment will not undergo extreme changes even though instantaneous surges or falls.

When should investors start with DCA?

The DCA strategy does not require investors to buy in at a very good timing. For high-quality assets whose prices will rise for a long time, users can buy them at any time. Therefore, what matters the most is finding blue-chip stocks in the market rather than choosing the timing to start the DCA. However, the performance of DCA ultimately depends on the cost of the investment. Investors can combine the DCA investment strategy with fundamental and technical analysis to find the relative low price point before starting the investment, which will help to improve returns.

How to use DCA strategy?

When it comes to making a DCA investment, investors need to follow the steps below:

1. Find the optimal investment project
2. Decide on the total amount and investment period
3. Consider the purchase intervals
4. Calculate the amount of each purchase based on the total investment amount and the number of purchases
5. Determine the Take-Profit price

After formulating a DCA plan, users can manually set a fixed time to purchase the same asset of the same value. Since the whole process is completed by mechanized operations and in order to avoid errors such as entering the wrong amount which could spoil the investment, many platforms have customized DCA investment tools. For example, users can enter the Auto-Investment platform under the Gate.io Earn on the bar section. Gate.io Auto-Investment supports flexible combinations of multiple currencies and different proportions. It is convenient for users to create their exclusive auto-investment plans and make long-term value investment.

Points to note when getting started with DCA

No investment strategy can guarantee profits. Although DCA can resist fluctuations, losses are still possible if the price of the underlying asset decreases for a long time. Users can make better decisions and reduce sunk costs as long as they conduct fundamental analysis on the market. Moreover, as Auto-Investment is a long-term strategy, it will take more time for investors to accumulate a certain amount of assets because multiple small-amount purchases cost more in handling fees than that of a single purchase. Although making purchases in batches and at regular intervals can protect assets from being locked due to improper capital allocation, it will also make users fail to take the chance of buying at the bottom .
The bull-bear transition in the financial market can easily happen over several years. If investors start to apply an auto-investment strategy in the early stage of a bear market, they may have to suffer paper losses for a long time. On the contrary, if they implement the strategy in the early stage of the bull market, although they can still get the dividends of the bear market, the returns are also much less compared with the one-time purchase at the price-rising point. Besides, long-term auto-investment will pile many funds on a single asset, which may weaken the effect of risk diversification.
Investors should consider all the above points when they plan to start auto-investment.

Backtesting

No matter what strategies are applied, backtesting is a proven practice. To find an excellent underlying asset from thousands of trading pairs and buy in, one needs to review enough historical prices . Taking Bitcoin as an example, investors can take a test on auto-investment to see the returns on the website dcaBTC.
For example, user A starts to buy in $10 BTC every week during a four-year period starting in August 2018. The value of Bitcoin that user A held so far is $8,350, an increase of 299% compared to the input cost of $2,090. If user A started to buy $10 BTC a year ago, the current value of bitcoins held would be $494, which is 6% less than the investment cost of $530. It can be seen that the rate of return on auto-investment depends on the price trend of the underlying asset during the period. Users can also check the comparison of the auto-investment results with the US stock Dow Jones index and Gold on the website, observing the difference in results when the auto-investment strategy is applied to different markets.

Conclusion

Auto-investment is a strategy used to buy a small amount of capital many times so as to resist price fluctuations and diversify risks. As a long-term value investment strategy, it is used by many institutions and passive fund managers. It is also suitable for investors lacking experience and users who do not have time to observe market trends. However, auto-investment can only help lower the entry threshold and deal with investment risks. To gain profits in the long run, users need to find a quality underlying asset to start with. Auto-investment has no high requirements for the timing of entering the market. Users can enter when the prices fall, but the strategy works only when the price will go upward in the future. Auto-investment is a long-term investment strategy which usually helps take profit rather than stop loss. Users should be far-sighted, so as not to buy the wrong underlying asset or to give up halfway through the price drop. Besides, timely reviewing the previous performances of the asset and making fundamental analysis, which can help investors make judgments to stop deductions, stop losses, continue deductions, or stop profits, will bring the superiority of auto-investment into full play, thus earning high yield.