Dollar-cost averaging (DCA) is a strategy where an investor divides up the total amount to be invested across periodic purchases of a target asset. Investors use DCA to reduce the influence of volatility over their investment, reducing their risk exposure.
Understanding the term
Dollar-cost averaging is so called as it opens the potential for reducing the average cost of the assets purchased. This allows investors to buy less of an asset when its price is relatively high and buy more units when the price goes lower. This allows investors to enter a position gradually rather than doing it in a single move. DCA is used in cryptocurrency trading as it averages out the investor’s returns, helping them take advantage of the market dips.
For instance, let’s assume a trader has decided to invest $15000 in a token priced at $100. In this case, the trader will end up with 150 tokens. However, if the trader decides to invest the same amount but spread over 5 months, the investment per month will be $3000. Now, if the price of the token falls below $100, the trader will end up getting more value for their money.
Dollar-cost averaging helps traders avoid the mistake of making lump-sum investments that are poorly timed. It reduces the overall impact of volatility on the price of a particular asset.