Dollar cost averaging (DCA) is a trading method consisting of purchasing a fixed amount of an asset at consistent intervals over a sustained period of time, rather than buying all at once. In theory, applying DCA can reduce the overall impact of volatility on a portfolio and reduce the average cost per unit of the asset being traded. That's because, if executed properly, this method can help the trader buy regularly when prices dip — assuming the market sees both highs and lows. DCA isn't without its tradeoffs, however, and it's important to keep a balanced view on the tactic's pros and cons.
In this article, we'll explore DCA in depth. Our goal is to help you understand what DCA is, how it works, the tactic's advantages and disadvantages, and some key considerations when implementing it.
- DCA involves a trader opening multiple smaller positions at regular intervals rather than committing a single lump sum once. The goal is to reduce the impact of market volatility on their portfolio.
- In theory, DCA could reduce the average cost per unit of an asset because the trader might be buying more of an asset during the dip and less during price spikes.
- DCA is considered a simple trading tactic because it can reduce the need to time the market when accumulating an asset.
- DCA bots are a popular choice to automate the tactic, bringing greater simplicity and reducing the potential for emotion-led decision making.
- Although popular, DCA isn't always the best option. In certain market conditions, it can be less effective than others, and could even lead to missed opportunities. Its long term success relies on the assets' long term price appreciation, which only traders themselves can try to predict.
Why do traders use DCA?
Every trader is unique and driven by their own motivations. However, traders often use DCA for the following reasons.
To manage market volatility
DCA can allow traders to mitigate market volatility by buying more of an asset when prices are low and less when prices are high. This is achieved by opening a consistent position size with each trade. With this approach, traders aim to avoid overpaying for an asset when prices are higher.
To avoid timing the market
Many traders consider DCA to be an effective alternative to trying to time the market, which is especially difficult given the inherent volatility of crypto. Meanwhile, they like that it removes some of the emotional influence involved in trying to find the perfect entry and exit point.
To simplify trading
Simplicity is another motivation driving many to adopt DCA. Because the tactic involves opening positions at regular intervals and for a similar value each time, you can automate much of the process using trading bots. Bots not only allow you to set the date and time to open a new position at, but also automate the open and close of a position at specific prices. This can remove complexity from your trading strategy and save you time, making life as a trader easier (in theory).
The advantages and disadvantages of DCA
Like any trading tactic, DCA brings both advantages and disadvantages.
Advantages of DCA
- It can make trading more accessible. DCA can help side step much of the complexity involved with other forms of crypto trading because of how rigid it is — open a $100 position to buy Bitcoin on the 25th of every month, no matter the market sentiment. Easy. The hard part is managing your emotions, which leads us to...
- It can promote trading discipline. Many would agree that one fundamental ingredient for trading success is to manage one's emotions. DCA can encourage discipline and better emotional mastery because of the above mentioned rigidity. It can require discipline to continue making buy orders during a massive price correction, for example. Like strengthening a muscle, DCA can help build discipline through repetition and consistency.
- It can potentially lower one's average costs. Because DCA can help traders buy more of an asset when prices are low and less when they're high, they can potentially achieve a lower overall cost per unit for the asset they're trading. This can be rewarding if they plan to hold the asset long-term and if (an important qualification!) the asset rises in value over time. Considering crypto's volatility, none of this is guaranteed to happen, of course.
Disadvantages of DCA
- Traders may miss opportunities in rising markets. One major downside to DCA is that it might not be optimal during prolonged periods of price increases. Here, trading with larger lump sums has the potential to outperform DCA. However, keep in mind that a market upturn can always be quickly reversed.
- DCA sometimes comes with higher fees. Traders can encounter higher fees when using DCA because it typically involves making a greater number of trades at consistent intervals to capitalize on market upturns and downturns. As always, be sure to study the fees of your chosen trading platform before you commit funds to an asset.
Keep in mind that DCA has a higher chance of being effective in a market with frequent ups and downs, as this cyclical movement can potentially bring the benefit of buying more units when prices fall and fewer units when they rise. Although DCA is a relatively passive form of trading, it's recommended to frequently monitor the market to see if the tactic is best suited to current conditions. For example, during periods of price appreciation, DCA can sometimes leave you with fewer units than if you'd traded a larger sum all at once.
Which traders is DCA right for?
Traders of all experience levels can apply DCA if it suits their own trading strategy.
We've already emphasized how beginners can, in the right circumstances, benefit from the tactic's simplicity. Some crypto trading experts even see DCA as an ideal starting point for inexperienced traders looking to gain exposure to crypto while managing volatility. According to them, by only trading with an amount they can afford to lose and opening positions periodically, beginners can start to understand market dynamics, how news events impact price action, and fundamental technical analysis. DCA can also be beneficial, they argue, to beginners who don't have large sums of money to trade with.
Meanwhile, more experienced traders who are either day traders or trade alongside full-time employment can find a use for DCA in their trading plan, due to the method's efficiency. Some of these individuals may use DCA to accumulate an asset they believe in the long term future of regularly, and potentially at a lower average cost per unit — all without requiring intensive market analysis. In those cases, they enjoy the rigidity of DCA, as it nudges them to stick to their trading plan. Trading bots can be a useful tool in boosting efficiency further by automating some of the work involved in trading with DCA.