The Importance of DCA Trading Strategy During a Market Correction

DATE PUBLISHED: NOV 29, 2022
20 MIN
DATE UPDATED: JAN 24, 2023

DCA trading reduces the impact of volatility when buying a large chunk of crypto. Read on to learn how it works.

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Investing isn't always easy. Even experienced investors often fail when they try to time the market and buy at the best times. When dealing with volatile markets, dollar-cost averaging can help by spreading out your purchases over time. It also encourages consistent investment behavior.

Using dollar-cost averaging, you invest a fixed amount of money in an asset regularly over a set period, regardless of fluctuations in the asset's price.

An investment's volatility is the degree to which it could rise or fall in value due to the uncertainty of the financial markets. The goal of DCA trading is to reduce volatility risk by lowering the average cost of investing.

Dollar-cost averaging can help investors mitigate the negative effects of market volatility by spreading out the cost of buying an asset over time. In practice, this method spares you the trouble of trying to time the market so that you can make your purchases at the lowest possible prices.

This article will explore what the DCA strategy is, how it works, and how you can use it to build wealth over time.

An Overview of the DCA Strategy in Crypto

The cryptocurrency market, due to its nascency and innovativeness, is unstable and prone to sharp price fluctuations. A clear example of this was in May 2021, when the market dropped more than 50% from its all-time high, which resulted in the liquidation of many short-term investors’ positions.

It’s worth noting that for investors following a DCA strategy, periods of market declines are the best time to increase holding positions. By initially choosing a price averaging strategy, users have available funds to buy at lower prices instead of buying the asset in one payment before the market declines.

Cost averaging requires investing a set amount of capital at regular time intervals, regardless of the market price. This reduces portfolio volatility, as the entry point is averaged by regular purchases of the asset across time, regardless of price.

The cryptocurrency market is unpredictable, so there is no way to accurately foresee future price movements and predetermine the best entry point. The DCA trading strategy allows you to take into account the impact of sharp price changes, where each subsequent entry into a position can be made at a lower price.

The basic principle of trading is selling an asset at a higher price than it was purchased. The problem is that it is impossible to reliably determine whether a given price is optimal for the future price of the same asset. A DCA strategy allows you to soften the impact of short-term price fluctuations on the future value of your investment.

Technicalities

It is important to consider the number of open positions in your portfolio depending on the time scale and the amount to be invested. For example, if you wish to purchase $10,000 worth of an asset to hold it for five years, you can divide your capital into equal portions and execute purchases weekly or monthly throughout a six-month duration.

The principle of DCA strategy in crypto is that the purchase of an asset over time will bring more effective results than buying it in a single payment. Thus it is possible to reduce the risks caused by market volatility.

It is important to highlight the fact that this averaging strategy is not risk-free. An investor still must determine the time range for entering the position and set the exit targets.

It is also necessary to take into account the asset in which to invest. Taking Bitcoin as an example, applying a DCA trading strategy, in this case, has proven to be extremely profitable. Bitcoin is an asset whose price is constantly increasing in the long term.

In this case, you can invest a set amount every month over one or multiple years, expecting it to grow over 10 years or more. Similarly, to capitalize on Bitcoin’s volatility, one can use DCA to buy coins daily for a month, expecting the price to rise over six months.

To a certain extent, dollar-cost averaging resembles the HODL strategy, with the difference that the latter involves accumulating an asset and holding it, while DCA is inherently dependent on target levels. It is also worth noting that DCA trading strategy is used not only for investments but also in both manual trading and automated trading with bots.

Bitcoin DCA Strategy

Rather than trying to time the market, most investors would do better by buying small amounts of Bitcoin regularly (every day or once a week). You can get the best prices, the worst prices, and every price in between if you buy every day. A Bitcoin DCA strategy offers three benefits:

  • It gives the best average price on Bitcoin
  • It saves time, and
  • It reduces FOMO (Fear of Missing Out)

If you had bought the crash in March 2020 or the dip in April 2021, you would have made lots of money. However, only a few investors have the insight and expertise to anticipate and capitalize on such market events. When you use the Bitcoin DCA strategy, you let the odds play the role of a stockbroker. If you can get the best average price, you don’t need to go through the stress of the education and research required for trading.

When combined with foresight, the Bitcoin DCA strategy is highly effective. As the time horizon expands, the strategy becomes more effective. Bitcoin's short-term losses will be evened out over time if the currency continues its upward trend.

Dollar-Cost Averaging: Building Wealth Over Time 

To use DCA strategy in crypto, an investor must put the same amount of money into the same cryptocurrency over time, no matter how much the price of the cryptocurrency goes up or down.

In the long run, this method usually achieves a result that is as good as, if not better than, timing the market.

New investors starting with a small investment can benefit greatly from DCA trading. Over time, even a small investment can yield significant returns.

How it Works

The DCA trading strategy couldn’t be simpler. Simply invest a certain amount of money into the same crypto regularly (monthly, if possible). You don't need to worry about the ups and downs in the value of your investment. Ensure you're putting the same amount of money into it whether the market is going up or down.

The amount of cryptocurrency that you purchase each month may change depending on its price. As the price of the crypto increases, the amount you can buy with a given amount of money reduces. You can buy more quantities with the same amount of money if the price drops.

In the long run, your average cost per share should be lower than if you had tried to time the market. Beginner investors benefit greatly from dollar-cost averaging. If you start with a small investment, you can increase your wealth over time.

How to Start Using DCA Strategy in Crypto

Understanding how DCA works is great, but the real value lies in putting it to use. One of the most common DCA implementations involves setting aside a predetermined monthly amount to be put towards purchasing a specific digital asset. This is because most people invest a portion of their salary and the salary is usually deposited on a specific day.

To tailor the DCA trading strategy to your specific needs, you will need to decide on the following:

  • Which cryptocurrency do you plan to invest in?
  • How often do you plan to invest?
  • How much money are you planning to put in?
  • How will you invest?

Which Cryptocurrency Do You Plan to Invest in?

If you're going to use the DCA strategy, it's best to do so with a cryptocurrency whose value you believe will improve over time. Bitcoin and Ethereum are often chosen because they have a reputation for being the most secure crypto projects.

How Often Do You Plan to Invest?

Rather than investing the entire sum at once, you should spread out your investments over a predetermined period and make equal monthly contributions.

If you're committed to dollar-cost averaging, you may end up investing at times when the market or a specific asset has dropped in value. This also means you may find yourself making purchases during times of extreme market volatility.

Although some investors may be hesitant to buy crypto during bear markets, if you buy when the market is down, you can snag some potentially profitable assets at rock-bottom prices. Dollar-cost averaging can help you take advantage of the "buy low, sell high" phenomenon by making purchases at times when others are more likely to sell.

How Much Money Are You Planning to Put in?

After determining the crypto you want to invest in and how often you want to invest, you need to determine the amount of money you want to use to buy the crypto. The amounts that you will be investing in each period should be the same.

How Will You Invest?

In addition to the amount and frequency with which you want to invest, you should also decide how you want to invest. Note that earning more crypto does not mean you’re earning more profit. The value of your crypto investment decreases when crypto prices fall.

Some Drawbacks of Dollar-Cost Averaging Frequency

Using a dollar-cost averaging strategy will result in higher trading costs because many trading platforms impose fees on each trade. DCA is a long-term strategy, which is good news. After two, five, or ten years, your fees may be small compared to the money you could make.

If you use Bitcoin DCA strategy and the market drops significantly, you may not get the large gain you would have gotten if you had invested all at once. Timing the market correctly is essential for making large profits, but not even the most experienced investors can reliably foresee the daily or weekly fluctuations that can make or break a cryptocurrency.

Using DCA trading strategy may be a more secure strategy for profiting from large market declines. Buying after a sharp increase in asset prices can leave you vulnerable to a subsequent decline. Buying assets at any point in their lifecycle, whether they are stable, depreciating, or appreciating, is a common part of a DCA strategy. Using a DCA strategy consistently has been shown to lower risk and improve performance over time.

Is a Dollar-Cost Averaging Strategy Viable for Crypto?

The DCA strategy in crypto is similar to setting up a recurring purchase order on a crypto exchange. In some cases, the volatility of cryptocurrencies can even exceed that of the stock market.

Buying when the price drops and selling when prices are high can increase your potential profit. DCA trading, on the other hand, is widely accepted as a more secure investment strategy than buying and selling crypto in one large chunk. It's less of a gamble and doesn't promise as much payoff, but it still gives you a shot at capitalizing on market fluctuations.

Though many may assume this wrongly, dollar-cost averaging can be used to generate substantial profits. Average purchase prices are typically thought of in terms of average exchange rate prices, but this is not always the case. The average purchase price could be quite low if you invest at a specific time and the price corrects around that time.

The DCA strategy is so effective at breaking into the cryptocurrency market that even seasoned investors rely on it. This is because they are aware of how tough it is to predict where the price will go high or low. This is why DCA is used by professional traders.

If properly implemented, the DCA trading strategy allows beginners to gain access to the same investment opportunities as seasoned investors. This strategy is also useful for investors with limited experience or time constraints. The key to achieving your financial objectives is to plan ahead and then stick to that plan.

Things to Note Before Using the DCA Strategy in Crypto

If one considers the DCA trading strategy for riskier assets, the success of this approach becomes questionable. Based on the huge number of new projects, many of which are likely to lose value over time, the strategy of buying such assets to hold for extended periods will result in portfolio losses.

When designing a strategy, it is worth considering market corrections, trends, and asset types. For example, in a bull market, the use of Bitcoin DCA strategy can be unprofitable since each successive purchase will be at a higher price than the previous one.

An averaging strategy is best used in an uncertain market; in case of high confidence in future price growth, a one-time trade will be a more beneficial solution.

DCA Bots By 3Commas

The Bitcoin DCA strategy is available for automated trading with 3Commas bots and provides effective trades for a set period. Using averaging and automating short-term trades has several advantages: 

  • When the price falls below the initial buy level, another position is opened, thereby averaging the position down.
  • The use of “Take Profit”, which moves along with the average price, increases your chances of profiting from your position, even if the initial buy price is not reached again.
  • Flexible settings to use the trading strategy in any market conditions.

Read more about DCA bots and other automated trading tools on the 3Commas blog.

Conclusion

A successful application of DCA strategy in crypto depends on knowledge and understanding of the market. If used correctly, this strategy can reduce the risks of losses while increasing profit potential along the way.

Due to the volatility and future potential of the cryptocurrency market, investing in digital assets has been and could continue to be profitable. A dollar-cost averaging strategy is something to think about if you want to profit from the volatility of cryptocurrencies in a relatively safe manner.

However, don’t forget to take into account the risks of investing in cryptocurrencies and your expected target profits. It’s worth remembering that the successful application of DCA trading depends on numerous factors. For this reason, it’s best to make your calculations based on your investing goals before getting started.

DCA Trading FAQ

  • If you want to increase your profits while trading cryptocurrencies, then DCA is the way to go. Using the DCA strategy in crypto, you can reduce your average cost of assets by taking advantage of market fluctuations without taking on excessive risk.

    The constant dollar plan (also known as DCA) is based on the assumption that the value of a cryptocurrency will rise over time. Investing with a DCA strategy means you can buy more assets than if you had invested at the peak of the market.

  • Due to its low price and promising future growth, Matic is an excellent coin for DCA trading. Matic is an Ethereum-based project that takes a novel approach to scalability and has the potential to completely alter how we view blockchains and their applications.

    Smart contracts can be executed at any time with no transaction fees, and throughput is greatly improved over what is possible on the Ethereum network at the moment. As a result, Matic is well-suited for use in decentralized exchanges.

  • To use DCA strategy in crypto, one must first select the specific cryptocurrency and establish a total investment amount. Then, rather than investing the entire sum at once, you spread out the investments over a predetermined period and make equal monthly contributions.

    Put a fixed amount of money away every month and watch it grow in value. Since most people want to invest some portions of their salary, and most salaries are deposited on a fixed day, many people opt for stable crypto projects.

  • DCA trading is widely regarded as a more secure approach to investing in cryptocurrencies than making large, sporadic purchases and sales. Trading with a smaller amount of capital carries a lower chance of success, but can still yield profits from market fluctuations.

    Cryptocurrencies, however, are highly risky and notorious for their volatility. Putting all of your money into cryptocurrency is a bad idea. If you're willing to take the plunge into the cryptocurrency market, it's important to arm yourself with knowledge and a plan.