Active trading can be stressful, time-consuming, and still yield poor results. However, there are other options out there. Like many investors, you might be looking for an investment strategy that is less demanding and time-consuming. Or just a more passive investment style.
But what if you want to invest in the markets but don’t really know how to start? More specifically, what would be the optimal way to build a longer-term position? In this article, we’ll discuss an investing strategy known as dollar cost averaging (DCA) – which provides an easy way to mitigate some of the risks of entering a position – and how to dollar cost average for those who are interested in pursuing this relatively passive strategy.
What is Dollar Cost Averaging?
Dollar cost averaging is an investment strategy that aims to reduce the impact of volatility on the purchase of assets. It involves buying equal fiat amounts of the asset at regular intervals. The premise is that by entering a market like this, the investment may not be as subject to volatility as if it were a lump sum.
The reason being, buying at regular intervals can smooth out the average price. In the long term, such a strategy reduces the negative impact that a bad entry may have on your investment.
Why Dollar Cost Average?
The main benefit of dollar cost averaging is that it reduces the risk of making a bet at the wrong time. Market timing is among the hardest things to do when it comes to trading or investing. Often, even if the direction of a trade idea is correct, the timing might be off – which makes the entire trade incorrect. Dollar cost averaging helps mitigate this risk.
If you divide your investment up into smaller chunks, you’ll likely have better results than if you were investing the same amount of money in one large chunk. Making a purchase that’s poorly timed is surprisingly easy, and it can lead to less than ideal results. What’s more, you can eliminate some biases from your decision-making. Once you commit to dollar cost averaging, the strategy will make the decisions for you.
Dollar-cost averaging, of course, doesn’t completely mitigate risk. The idea is only to smooth the entry into the market so that the risk of bad timing is minimized. Dollar cost averaging absolutely won’t guarantee a successful investment since other factors must be taken into consideration as well.
How to Dollar Cost Average
Let’s say we’ve got a fixed dollar amount of $10,000, and we think it’s a reasonable bet to invest in Bitcoin. We think that the price will likely range in the current zone, and it’s a favorable place to accumulate and build a position using a DCA strategy. We could divide the $10,000 up into 100 chunks of $100. Each day, we’re going to buy $100 worth of Bitcoin, no matter what the price. This way, we’re going to spread out our entry to a period of about three months.
Now, let’s demonstrate the flexibility of dollar-cost averaging with a different game plan. Let’s say Bitcoin has just entered a bear market, and we don’t expect a prolonged bull trend for at least another two years. But, we do expect a bull trend eventually, and we’d like to prepare in advance. Since this investment portfolio has a much larger time horizon, we’d have to be prepared that this $10,000 will be allocated for this strategy for another few years.
We could divide the investment into 100 chunks of $100 again. However, this time, we’re going to buy $100 worth of Bitcoin each week. There are more or less 52 weeks in a year, so the entire strategy will execute over a little less than two years. This way, we’ll build up a long-term position while the downtrend runs its course. We’re not going to miss the train when the uptrend starts, and we have also mitigated some of the risks of buying in a downtrend.
Closing Thoughts
Dollar cost averaging is a redeemed strategy for entering into a position while minimizing the effects of volatility on the investment. It involves dividing up the investment into smaller chunks and buying at regular intervals. That is all there is to those wondering how to dollar cost average.
The main benefit of using this strategy is the following. Timing the market is difficult, and those who don’t wish to actively keep track of the markets can still invest this way. Although dollar cost averaging can make some investors lose out on gains during bull markets, losing out on some gains isn’t the end of the world as dollar cost averaging can still be a convenient investment strategy for many.
