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What is Dollar Cost Averaging and why is it the best strategy for beginners?

by | May 27, 2019

Important notes:

  • This article is specifically only for educational purposes, it is NOT financial advice.
  • Investing in Bitcoin (or any cryptocurrency) is inherently risky and can lead to total loss of funds; do not invest any money that you cannot afford to lose.
  • The strategy described in this article is intended for Bitcoin (BTC / XBT) ONLY and does NOT apply to anything else in the crypto world.
  • Dollar Cost Average and HODL-ing can only be continued as long as the underlying fundamentals of the asset do not inherently changed. It is the investor’s own duty to conduct the proper research on the state of fundamentals of the asset.

The thing that most beginners in the cryptocurrency world struggle with is how to invest their money to generate the most profit. In this article we will try to explain and show the strategy which we believe is one of the easiest, safest, and brings the highest likelihood of profitability! It might even turn out more profitable than the vast majority of seasoned traders could ever achieve. The name of this magical strategy is Dollar Cost Averaging!

TL;DR: the conclusion is that for a beginner in the crypto space without prior trading experience/skills, the strategy of Dollar Cost Averaging is much simpler and superior over trying to “time the market” by trading or just “Lump Sum Buying”. This means consistently buying a fixed USD amount periodically (weekly/monthly) is very likely to produce better results than the great many of traders would achieve over longer periods of time. While you slowly accumulate more Bitcoin against an automatically optimizing average purchase price, you can focus your time as a beginner to learn the basic fundamentals of Bitcoin and crypto landscape and/or study proper trading techniques that can perhaps enhance your investment portfolio management over time.

A notorious problem that most beginners face is that the vast majority will always begin late in a bull market when price is already getting near its top. They hear all over the news and from their friends about the massive gains Bitcoin is making and they want to jump on board of the rocket ship that will take them to the moon. Usually loans and double mortgages are taken out, credit cards are maxed, and they are already dreaming of the houses, boats and Lambos that they’re going to buy. Soon after everybody has loaded up on Bitcoin at the highest prices possible, there will be no buyers left and that’s when sellers take over. The market tops, the price tumbles, and recent buyers are quickly in deep losses – this is when panic sets in and many will panic sell at huge losses. Bitcoin has had multiple bear markets where prices dropped more than 85% from its peak and lasted multiple years before even breaking even again.

Make no mistake, such event can happen at any time (and even in the biggest bull runs, Bitcoin crashes 30-40% on many occasions) and if you went all-in close to all time high, it will be a rough and painful experience. This article is aimed at preventing this from happening to you, the reader, of which I am sure many of you will read this article near the next all time high. So I encourage you to learn from this article and avoid the outline scenarios from happening to you. A proper strategy in the beginning is vital for your long term success.

Before explaining the power and magic of Dollar Cost Averaging, specifically for Bitcoin investing, I will first point out the problematic nature that the other common investment strategies, “lump sum buying” and “trading”, encounter.

Lump Sum Buying

This is how most people start investing in Bitcoin. It means that you take the whole sum of money you want to invest and use it all at once to buy Bitcoin in one single trade. And then just sit and wait until you get rich. But because most new people start near the top of each bull market, the previously described situation will happen and most newcomers will get “rekt” (crypto slang for encountering big losses) instead of becoming rich. The problem with the lump sum buying strategy is that it can only give the best gains if the timing is perfect (near the bottom of the market).

For beginners that are not savvy investors/traders, this would be pure luck if you happened to get involved in Bitcoin when the price is near the bottom. Otherwise, timing is extremely difficult and the odds are not in your favor, because most of the time the timing of a beginner investor will be completely wrong when lump Sum buying.

Active Trading

In the crypto space there are hundreds, if not thousands of platforms, (social media) channels, influencers, etc. that teach or promote the art of trading Bitcoin and/or altcoins. The current price, charts, indicators, etc. are the talk of the day and trading strategies and predictions are being shared continuously. Many would like to believe that trading with Bitcoin is the best way to crypto riches. Buying and selling your Bitcoin back and forth with fiat, or against altcoins to increase your portfolio by swing trading (or worse even: day trading) are the most common ways to do this. However, if you are new in crypto and have no prior experience in trading other assets, there is a 95+% probability that you will end up losing more money than the rising price of Bitcoin can compensate. It is well known that more than 70% of traders across all assets eventually lose money from trading.

One of the most important goals in investing is capital preservation, or in other words – not losing money! For skilled traders, it is strict money management that prevents them from losing money. For the uneducated beginner, it is refraining from actively trading that prevents them from losing money.

Only those that have the right mental attitude, the right amount of skills/experience. and/or market moving amounts of money will stand a chance. All the rest are most likely better off with the simplest form of timing the market and investing: Dollar Cost Averaging!

Dollar Cost Averaging

How does Dollar Cost Averaging work?

It is very simple: every week or every month the investor buys an asset (in our case Bitcoin) for a fixed amount of dollars each time no matter what the price is. Example: buy $50 worth of Bitcoin every week forever. Because the price of Bitcoin can be different each period, the amount of Bitcoin that you buy, changes depending the price. Any time the price is lower, you will automatically buy a larger amount of Bitcoin, anytime the price is higher, you will automatically buy a smaller amount of Bitcoin. Let’s take a look at a practical example with apples:

Each week I will buy $50 of apples:

Week 1: price of 1 apple is $1. I can buy $50/$1 = 50 apples

Week 2: price of 1 apple is $2. I will buy $50/$2 = 25 apples

Week 3: price of 1 apple is $0.50. I will buy $50/$0.50 = 100 apples

I spent 3 x $50 = $150 dollars on apples and was able to buy 175 apples. The average purchase price was: $150/175 apples = $0.86 per apple. As you can see, because I buy automatically more apple when the price is lower, and less apples when the price is higher, my average price is favorable, just by consistently buying for the same amount each week. Hopefully this example makes the basic principle clear.

The idea is that even with this blind automation, over a long period of time, your average purchase price will be more optimal than you could realistically achieve by “timing the market”. And the beauty of it all, is that this strategy can be applied stress and hassle free, compared to the traders that are always attached to their screen trying to compete with all the wolves in the market. Even though the technique is quite simple, it is however not the easiest, because it requires some discipline to actively make your purchase each week/month. It is very easy to skip more and more and eventually not be buying at all and missing out on most of the buying opportunities. Very few exchange services have an automated buying feature that will take care of this process in a passive way (Coinbase has this feature), so applying this strategy may rely heavily on your own discipline.

Does it actually work?

Well, we can check out a few examples that show the power of Dollar Cost Averaging over lump sum buying and assuming that (besides pure luck) there is no way that trading can lead an unskilled trader to profitability. The data taken is from research from an article published by blogger and Bitcoin trader Ugly Old Goat and our article is inspired by his Medium post. The article also shows a complete table of all data points (read full article here). The example shows the results of monthly buying $500 worth of Bitcoin, starting at the 2 worst possible times in recent history: the high of the bull market in 2014 and the high of the bull market in 2017. These are obviously also the worst times to start as a beginner by Lump sum buying (yet, the most common time that most beginners enter the market).

The first tables show the results of DCA (Dollar Cost Averaging) and LSB (Lump Sum Buying) when started at the high before the bear market in 2014.

Dollar Cost Averaging

DateBTC priceInvested (total)BTC totalAvg priceValueProfit/Loss
01/15/2014$874.71$5000.57161$874.71$5000.00
12/15/2018*$3,217.01$30,00050.48679$594.21$162,416441%
05/15/2019$8,114.63$32,50051.05187$636.61$414,2671,174%

*: (Around the) low of the latest bear market so far

Lump Sum buying

DateBTC priceInvested (total)BTC totalAvg priceValueProfit/Loss
01/15/2014$874.71$32,50037.15517$874.71$32,5000.00
12/15/2018$3,217.01$32,50037,15517$874.71$119,528268%
05/15/2019$8,114.63$32,50037,15517$874.71$301,500828%

And now let’s see what happens when you started at top of the last bull market in 2017:

Dollar Cost Averaging

DateBTC priceInvested (total)BTC totalAvg priceUSD ValueProfit/Loss
12/15/2017$17,601.94$5000.02841$17,601.94$5000.00
12/15/2018$3,217.01$6,5000.92879$6,998.35$2,987.92-/- 54%
05/15/2019$8,114.63$9,0001.49395$6,024.30$12,122.8534%

Lump Sum Buying

DateBTC priceInvested (total)BTC totalAvg priceUSD ValueProfit/Loss
12/15/2017$17,601.94$9,0000.51131$17,601.94$9,0000.00
12/15/2018$3,217.01$9,0000.51131$6,998.35$1,644-/- 81%
05/15/2019$8,114.63$9,0000.51131$6,024.30$4,049-/- 55%

 

Results

If you started Dollar Cost Averaging at the All Time High (ATH) of 2014, you would at this point still be heavily outperforming Lump Sum Buying with 1,174% vs. 828%. And also, you would have accumulated a lot more Bitcoin by Dollar Cost Averaging.

If you started to invest in Bitcoin around the ATH of 2017, at the low of the following bear market (so far), with Lump Sum buying your loss would be 81%, while the loss on capital as DCA investor would only be 54% on invested capital.

By the month this article was written, the Lump Sum investor was still at 55% loss, while the DCA investor is already 34% in PROFIT, while we are still far away from ATH!

Conclusion

As you can see, without any skill or luck in terms of trading or timing the market, it can be very simple to outperform Lump Sum Buying without spending the time and effort that it would take to become a consistently profitable trader (which has a very low probability). You may end up very lucky if you were to buy in at precisely the right time, but when you enter as inexperienced beginner, this relies too much on pure luck. But the further away the price is above the last ATH, the higher the risk becomes that you are starting at the wrong time and Dollar Cost Averaging becomes the safer strategy.

At the same time we have to be realistic that the example as studied is based on historical data and that nothing in the future is certain to repeat – but the odds definitely seem to be in favor of the DCA investor. Also, the higher the market cap becomes, the more difficult it will be to move the price higher percentage wise. This also means that the profit percentage results as displayed since 2014, will likely not be repeated in the same amounts in the future.

Generally speaking, if you are a beginner in the world of cryptocurrency and have no prior experience in trading/investing, the most sensible way to start would be to Dollar Cost Averaging by making weekly or monthly fixed purchases of Bitcoin and continue to rigorously doing so for a considerable time, especially if prices are well past the last ATH when you are reading this. And while you are accumulating slowly and building up the stomach for the wild price swings that are common for the Bitcoin market, you can take your time to research and do your due diligence to learn about all the aspects around the Bitcoin space and/or diligently study the proper trading skills before risking any of your hard earned money with that type of risky speculation.

PERSONALLY (if I didn’t have any Bitcoin yet) I would be comfortable allocating 20% to 30% of the money that I want to invest in Bitcoin as a lump sum first purchase, as long as Bitcoin has NOT surpassed its last ATH yet (currently ATH stands at roughly $19-20k). With the rest of my money allocated for Bitcoin, I would start DCA strategy. But that is just my personal opinion and certainly everything depends on your own personal risk appetite – i.e. how you would feel if after your initial 20% investment, the price tanked 40% from your purchase price. If that would make you lose sleep, your first purchase needs to be much lower or just stick with DCA strategy only.

Final thoughts

In this article we only discuss our entry strategy that is most suitable for beginners and assume that you plan on holding long term. An exit strategy or profit taking is not part of the scope of this article, partly because exiting and profit taking are very much depending on personal goals.

Good luck and safe, responsible, but profitable investing everyone!

Disclaimer:

This article was written to the best of our knowledge with the information available to us. We do not guarantee that every bit of information is completely accurate or up-to-date. Please use this information as a complement to your own research. Nothing we write in any of our articles is intended as investment advice nor as an endorsement to buy/sell/hold anything. Cryptocurrency investments are inherently risky so you should never invest more than you can afford to lose.

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