Dollar cost averaging (DCA) is one of the most popular methods of long-term investing methods. Many respectable traders and investment firms have built a successful track record utilizing dollar cost averaging strategy. However, there is a big misunderstanding of what dollar cost averaging is.
When people hear dollar cost averaging, they think of investing a certain amount of capital periodically across a certain amount of time. Though there is nothing wrong with that, it is called dollar averaging over time.
Time Based Dollar Cost Averaging
Let’s clarify what time-based dollar cost averaging exactly is.
You have 100$ to invest and you do not want to take the risk of timing the market. So, you commit to purchasing a set dollar figure periodically.
A conservative approach would be the following scenario;
You have 100$ to invest
You invest 10$ on the same day of each month regardless of the price.
You don’t time the market and you build up a position over 10 months averaging into a price.
Considering Bitcoin on the long-term trends up, by averaging your entry across 10 months your position is more likely to be in profit than not.
An aggressive approach would be the following scenario;
You have 100$ to invest
You invest 10$ every single hour regardless of the price.
Now, you are a lot more exposed to the price action as you can only average your price for 10 hours. If the price moves away from you after 10 hours, your position will be underwater. The same argument can be done for over 10 months, but what you are betting is that the price will go above your average entry price over the course of 10 months which has a higher probability of happening than betting on a 10-hour period.
We have made an experiment where we invested 0.10$ every MINUTE. You watch what happened and how we managed that position with our market making bot here.
Value Based Dollar Cost Averaging
This is where I want to put more focus because it is greatly undervalued and not many people talk about this strategy.
In Value Based Dollar Cost Averaging, instead of investing based on time like same day on every month, you invest when the price of the asset changes. The plan here is, you invest a set amount of dollar figure every time Bitcoin goes down by x%. You can buy every time it goes 1% or 10% that is totally up to you.
Let’s explore it a bit further and see how it can be a lot more predictable and profitable than DCA’ing based on time.
You have 100$ and you want to invest 1$ every time bitcoin goes down 1% from your entry point. Bitcoin is 20,000$ when you decide to invest. (Yes, the worst possible time)
Here is your buying plan and prices;
1- 20,000$ investing 1$
2- 19,800$ investing 1$
3- 19,600$ investing 1$
. . .
98- 400$ investing 1$
99- 200$ investing 1$
100- 1$ investing 1$
Obviously, we can safely assume that Bitcoin’s price will not go to 1$ anytime soon. So, let’s put that into a relative scenario in the big picture.
If you entered at the all-time high right at 20,114.5$ and you have dollar cost averaged whatever percentage drop you are comfortable with for the same dollar figure. Your local low being at 10,900$, you could get an average price of 14,456$. After 15 days, you would be able to sell the position for 11.5% profit.
You might be asking how do I know when to sell? Aren’t we avoiding to time the market? Yes, we are but at one point we have to sell the position we have built up. So, we suggest setting a take profit percentage where you close the position and start building again. In this example, if your take profit was 10% which is relatively nice for 15 days, you could close the position.
What if I had a bigger take profit than 10%?
Well, you got in at 20,114.5$, right? Your low since you got in was 3150$ roughly. Therefore, we can assume that using the same method mentioned above, your average entry price would be 7927$. When we have established a local high in the summer of 2019 at around 14,000$ range, your position would be up 80% which is always a good target to start taking profits.
But as a trader who got in at the absolute top, we can’t expect one to take profit at 80% as he would be waiting for 200% gains as a degenerate moon boy. So, what would have happened if you kept holding and have never sold like our moon boy example.
As of today, Bitcoin is sitting at 9210$ and your position with an entry price of 7927$ would be up 17.14%. Not a bad time to take profits to rinse and repeat.
We have tried scalping Bitcoin using dollar cost averaging. Watch our 24 hours of time lapse scalping bitcoin with dollar cost averaging.
Conclusion
If you haven’t made about 100% gains between 2018 January to 2020 January, you should look into utilizing this strategy.
Luckily, we have built 2 different bots that dollar cost averages based on time and based on value.
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