Although cryptocurrencies are a new asset class and are behind the potential disruptive technology of blockchain, when it comes to investing there are a number of key strategies that should be used due to the way financial markets function. One of the most fundamental strategies is called Dollar Cost Averaging. Dollar Cost Averaging is the strategy of buying an particular asset on a periodic basis for a prolonged period of time. You should also use around the same amount of funds on each purchase. This allows you to scale into a position that averages to a cost basis around the longer term movement of that particular assets. It acts as a hedge against price action going against your investment immediately after purchasing it.
To show how this works, I will share my #STEEM purchases during the first quarter of 2018:
As we know, the price action was lower which made me purchase at lower prices on the way down. However, you can quickly realize how this strategy could potentially be helpful. My overall average cost is $2.78 per #STEEM. If I use a current price of $3.55, you can see that my position is up about 28%. However, if I would have invested my full amount of fiat at the first purchase (at $3.90), I would have a 9% loss at this moment. Clearly a worst position than I am in right now.
Another perspective is what would have happened if the price would have went up. Certainly, investing more at a starting point when at asset goes up in price represents the best option but from a risk management perspective, by dollar cost averaging you could still participate in rising prices. So there is an opportunity cost in the case an asset goes up in prices. However, given the volatility seen in cryptocurrencies, risk management strategies should always be the best option.
Another example to show the benefits of dollar cost averaging is that it stabilizes your average cost basis to protect against volatility. So, in a declining market it would make your breakeven closer to reach if the price goes back up and in a rising market, it will make the breakeven higher. To see as an example, see my purchases from above in a chart from coinmarketcap.com:
As you can see, given the declining prices in Q1 2018, my average cost is $2.78. This shows that my breakeven is lower now than if I would have only purchased at the first price point of $3.90. Instead of needing a higher percentage increase to get to breakeven, I am actually positive now. Much better from my perspective.
As you can see from above, the value of the strategy is that as an investor you do not need to worry about investing at the top of the market or trying to decide when to get in or out of the market. Remember, it is virtually impossible to really time the market so strategies that work around timing work best; particularly when in an asset class that is so volatile.
What are your thoughts of this strategy? Does it convince you as a good risk management approach? Please let me know your thoughts. I look forward to engaging with you on this subject.
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