Market volatility is inevitable with cryptocurrency. This is regarded as a bittersweet experience for traders and investors. However, knowing asset prices adapt to changing trends –these trends determine the market situations. Therefore, it is critical to understand their difference to make good decisions for your portfolio.
Consequently, one way to distinguish between a crypto trader and a crypto investor is how they take advantage of the market volatility. Traders frequently aim for quick gains while investors concentrate on the long term. Nevertheless, despite their differences, one person may simultaneously be a trader and an investor, depending on how well they can combine strategies to increase the value of their portfolio.
As an investor, making a profitable decision for your portfolio is crucial to growing a balanced portfolio and less affected by the substantial price fluctuation of the crypto market. So, since an investor's aim is long-term profit, what ideal investment strategy guarantees this without the fear of losing money or timing the market? Therefore, instead of timing the market, you can spread out the total amount to be invested among multiple crypto assets using an investment strategy known as Dollar Cost Averaging.
What is Dollar Cost Averaging (DCA)?
Dollar-cost averaging (DCA) is a financial strategy that seeks to reduce the impact of volatility on asset purchases. It entails purchasing assets in equal installments at regular intervals. DCA aims to divide your investments into fixed periodic investments to reduce the impact of volatility on your overall investment. This means it is the technique of purchasing assets in tranches over time to average the prices paid and account for price swings due to volatility.
DCA is peculiar to only crypto investment. It has been used in traditional investments such as the stock market; it has been successfully applied for a long time in the stock market as an investment strategy. Therefore, you buy in at both the market highs and lows when you use the dollar cost averaging strategy.
DCA aims to profit from market downturns without putting too much money at risk. As such, it is made to counteract any harm that short-term market volatility may do to an investment. Hence, if an asset's price declines while you are dollar-cost averaging, you could still profit if it increases again.
How Does DCA Work?
DCA is a simple investment strategy an investor, especially a newbie in the crypto space, can use to build wealth and a balanced portfolio over a period. However, this strategy ignores the steady rise and fall of the crypto market and would potentially put you in a position of profit by taking advantage of buying low at some point and selling high.
To implement this strategy, you must determine the total amount you wish to commit, the specific crypto asset you want to invest in, and the investment duration. Then, instead of putting the full amount all at once, you spread it across periodically over the given duration; this means you invest the amount in tranches and equal installments over the stated period.
For instance, if you want to invest $12,000 over one year, you can decide to do a quarterly base DCA where you invest $3,000 on a particular asset. Or, you can invest $1,000 monthly for 12 months. The idea is to spread your investment with smaller amounts without considering the asset's market price at the point of purchase.
Frankly, this strategy is essential because it is challenging to identify when an asset has reached the lowest price before bouncing back; thus, rather than investing all of your funds at once, it is usually wiser to use the DCA and wait to see if the asset dips further. However, it is ideal and beneficial to consider the crypto asset to use for DCA. Hence, it is valuable to use a cryptocurrency that you anticipate will exist and increase in value in the future. As a result, most investors choose Bitcoin or Ethereum, as these cryptocurrencies are regarded as the most stable crypto projects.
Furthermore, you can invest manually or automatically with various platforms that support the DCA strategy. When you select a platform, you must link your accounts and choose the period of deduction, the specific crypto asset, and the amount to be deducted regularly. This eliminates the emotional stress associated with market timing and allows you to build your portfolio without worrying about price movement.
Benefits of DCA
- It assists in reducing the risks associated with poor market timing, such as buying only when prices have already increased.
- It eliminates emotion-based decisions on your investments and puts you in a position of profit in the long term.
- It supports the routine of consistently investing to accumulate wealth over time. And since it operates periodically, you won't have to worry about timing your investments.
Drawback of DCA
- Since DCA does not consider the market's fluctuation, the returns are not always high. Hence, DCA is more of a risk management strategy than a way to maximize investment return.
- The DCA strategy only works effectively when the market prices are falling, i.e., in a bear market. On the other hand, using the DCA investment strategy during a booming market, i.e., a bull market, may result in a loss.
- Another drawback of DCA is that you may be faced with high transaction fees over time, as there are transaction fees you'll incur when purchasing and exchanging the asset on exchanges.
DCA exists under the tenet of regularly investing a predetermined sum of money into a particular asset. Therefore, it is considered a relatively safe way to invest as it is one way to manage risk in cryptocurrency. However, you should proceed with caution when investing in DCA, mainly because not all cryptocurrency has the potential for a profitable return. Therefore, before deciding to use the DCA investment strategy for crypto investments, always do your own research (DYOR).
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