The concept known as dollar cost averaging, or DCA, has long been used to reduce the volatility of stock and bond market portfolios and minimize the risk inherent in these investments. Dollar cost averaging takes many forms, including making periodic investments in a diversified mutual fund, reinvesting dividends to purchase more shares and buying into a workplace retirement plan like a 401(k) or 403(b).
The idea behind dollar cost averaging is easy to understand, and it is designed to put the old bromide “buy low, sell high” into action. With dollar cost averaging, the investor purchases the same amount of their chosen investment, i.e., individual stock, mutual fund, bond portfolio, etc. month after month and year after year. Investing the same amount on a periodic basis means the investor purchases fewer shares when the investment is riding high and more when its price is depressed. Over time, this helps to even out the swings in the market, reducing volatility and tempering risk.
Dollar Cost Averaging Into the Cryptocurrency Market
If there was ever a case for dollar cost averaging, it is in the cryptocurrency market. Cryptocurrencies like Bitcoin, Ethereum and Litecoin, can fluctuate 10%, 20% even 30% or more in the space of a single day, week or month. That extreme volatility makes dollar cost averaging a very valuable concept for any cryptocurrency investor to understand.
It is easy to dollar cost average into your favorite cryptocurrency, and you can do it on any exchange. If you want to dollar cost average into this potentially lucrative but highly volatile marketplace, there are a few things you will need to keep in mind.
Link Your Bank Account
The first step in dollar cost averaging is to set up your funding source. That means linking a bank account, credit card or other payment system on the cryptocurrency exchange of your choice.
Depending on where you live, it can take anywhere from a few days to a few weeks for your bank account to be fully linked, and until that happens, you will not be able to make any purchases. The exchange will verify your bank account by making a few small deposits, and you will need to sign on to enter those amounts.
Once the bank account or other funding source has been linked, you can set up your recurring purchases. Depending on the exchange, you can make purchases every day, every week, every month or every year. You can also set the day of the month on which to make your purchases, and that can make it easier to track your transactions and manage your bank account.
There is one important thing to understand when dollar cost averaging into the cryptocurrency market, and that is the price you will receive. Since the price of Bitcoin and other cryptocurrencies is so volatile, the day you buy can make an enormous difference in how much you pay.
Some cryptocurrency exchanges lock in the price on the date you select, even if the funds are not immediately transferred. Other exchanges do not lock in the price, and that means the price you pay could be different from the price on your chosen purchase date. That is an important distinction since it can take a few days for the funds to move from your bank account to the exchange.
Contact Your Bank
One final note about dollar cost averaging into the cryptocurrency market – it is a good idea to contact your bank before you make your first purchase. Giving the bank a heads up can help you avoid any unnecessary delays since these purchases can sometimes trigger fraud alerts.
Once you notify your bank that you plan to buy Bitcoin or another cryptocurrency, the DCA process should be pretty straightforward. You will want to keep track of the purchases you make, along with the prices you paid and any commissions that were added. This will make tax planning, and tracking your profits, a lot easier.