The DCA is a strategy of periodic purchases of assets in fixed sums. In fact, as we shall see below, it is one of the most popular investment strategies.
Introduction and strategy overview
In reality, although the principle remains the same, DCA (Dollar Cost Averaging) is applied in a wide variety of fields. The one we're most interested in is the cryptocurrency market.
This strategy can also be seen as a long-term investment plan, which minimizes the impact of price fluctuations and thus reduces the risk of loss.
According to William J. BERNSTEIN, in his book entitled "DATAQUEST", the investor using DCA should determine two parameters: the invariable sum to be invested and the timeframe between each investment. This study shows that the safest timeframe in terms of balance between return on investment and risk would be 6 or 12 months.
According to Richard CAYNE, if you're worried about market risk or the timing of purchases, then it's best to spread this risk over a number of entry points, with the same amount each time. In this way, if the market falls, more units are purchased with the same amount. If the market rises, the value of units already purchased increases.
In recent years, various cryptocurrency investment simulators, via the DCA, have emerged. These include sinvestir.fr, coinactucrypto and whalinvest.
A few of the world's leading centralized exchanges, such as Binance and Crypto.com, currently enable DCA automation. Although we believe it would be better to secure your investments using a cold wallet (hardware wallet for offline cryptocurrency storage) such as Ledger, for example, less experienced investors would also benefit from learning about DCA.
There are several advantages, but also a few disadvantages, to using DCA. We'll go into these in more detail just after explaining how it works.
Operating mechanism
It involves selecting a digital asset in general, or a cryptocurrency in particular, and investing the same amount in it, at the same frequency, regardless of the asset's price, over a well-defined period. As a rule, this process is applied simultaneously to several assets by any investor.
In this way, the investor receives a higher proportion of assets during bear markets (periods of generalized decline in the financial markets) than during bull markets (periods of generalized rise in the financial markets), and thus obtains an attractive overall capital gain in relation to the value of his investment.
For example, an excel file can be kept and updated regularly, in order to keep the data relating to the prices of the assets concerned up to date. The following columns can be added to this file for the planned investment end date: capital invested, total quantity of tokens obtained, average acquisition price, final capital obtained and performance.
DCA types
There are various types of DCA: Enhanced DCA or EDCA, Smart DCA or SCDA and simple DCA, commonly known as DCA.
The enhanced DCA or EDCA method involves investing, not a fixed amount, but a variable amount based on the share price, at the same frequency and for a pre-defined period of time. This improves the performance of the simple DCA strategy.
Example of DCA
En prérequis, nous supposons que nous souhaitons investir environ 300$ par mois.
- The 1st month, the market is down, we invest just over $300. Let's say $450
- The following month, the market rises, and we invest $150.
- The 3rd month, the market is down, we invest $450.
We can see that, over time, we buy more assets in periods of declining markets, providing us with a greater overall quantity of assets than that generated by the DCA alone at the end of the investment period.
Smart DCA or SDCA uses an automated system to determine the right time to invest.
The fundamental difference between EDCA and SDCA lies in the technique used to determine the amount of investment to be spent at each time interval.
DCA benefits
Its advantages are many.
- It enables any ordinary investor, whether or not they know how to trade financial assets, and whether or not they have any knowledge of financial markets, to invest while limiting risk.
- By regularly injecting savings that could otherwise have been spent on day-to-day living, it helps you save over the long term.
- The average cost of financial investment is reduced. In fact, as mentioned above, its mechanism enables you to amass large quantities of assets when markets are at their lowest.
- With this strategy, you don't need to set any other goals to earn passive money. In fact, it's probably one of the easiest ways to save money today.
- As the risk of using this strategy is lower, it has a positive impact on the psychology of investors. As a result, they avoid fear-driven action (FOMO or Fear of Missing Out) and concentrate on DCA, which is much easier to manage both emotionally and financially.
DCA disadvantages
While there are many advantages to using this mechanism, there are a few disadvantages.
- Investors using it very often lack sufficient liquidity. This greatly reduces their chances of making significant gains, since they don't have the opportunity to buy assets in large quantities during bear markets. This is the main drawback when choosing this DCA.
- If DCA is applied incorrectly, it can quickly become uninteresting. Indeed, since it's a long-term strategy, it's important for the investor who uses it to buy cryptocurrency regularly, but above all to hold on to it over time. As a result, if the investor finds it difficult to hold on to his tokens for long, choosing this strategy would become counterproductive.
Other financial market investment strategies
In addition to DCA, there are other major investment groups. Here are three of them.
- Value Investing → Is an investment strategy aimed at always buying shares from companies at a lower price than their real values.
- Growth Investing → Is a model focused on increasing the investor's capital.
- Momentum investment → Is an investment strategy based on buying assets that are trending upwards, or shorting assets that are trending downwards.
Conclusion and outlook
Although DCA is an old practice, originating in the world of equities and investment funds, it is still very useful, especially for those new to the financial markets.
It's true that Binance and other centralized exchanges already allow you to invest in DCA. However, it would be even more prudent to be able to do so in decentralized finance. In this sense, we could ask ourselves, for example, "How can we do DCA via decentralized finance?"
