The cryptocurrency market has experienced steep declines over the past few days, causing significant panic among investors. On Monday, August 5, 2024, Bitcoin fell by over 11%, while Ether lost 25% of its value, marking the cryptocurrency’s biggest one-day decline since 2021. Cumulative liquidations in the futures market exceeded $1 billion.
These adjustments may seem scary, but for investors using the Dollar-Cost Averaging (DCA) strategy, they are an opportunity to build portfolio value over the long term. DCA is an investment method that involves regularly putting a fixed amount of money into an asset, regardless of its price. This way, market corrections are not seen as a threat, but as an opportunity to acquire more cryptocurrencies at lower prices.
What is Dollar-Cost Averaging (DCA)?
The Dollar-Cost Averaging (DCA) strategy is based on systematically investing in a selected asset at regular intervals, regardless of its current market price. The key assumption of this method is to spread the investment over time, which allows to minimize the risk associated with short-term price fluctuations. In practice, this means that the investor sets a fixed amount that is regularly invested – for example weekly, monthly or quarterly – regardless of whether the asset price is rising or falling.
Why is spreading your investment over time beneficial?
Financial markets, especially cryptocurrencies, are notoriously volatile. Prices can rise or fall dramatically in a short period of time, making it incredibly difficult for even experienced investors to predict the best times to buy. DCA eliminates the temptation to “time” the market—trying to predict when it’s worth buying an asset at the lowest possible price. Instead, investors consistently average out the purchase price over a long period of time.
DCA mechanism of action:
- Regular shopping: You set a fixed amount to invest over a set period of time, such as $100 per month in BTC. No matter what the price of Bitcoin is at the time, you make a regular purchase of $100, such as on the first of every month.
- Buying more for less: When the price of an asset falls, you can buy more units for the same amount (e.g. when Bitcoin falls from $50,000 to $40,000, you buy much more of it for the same amount). Conversely, when the price rises, you buy fewer units.
- Cost averaging: Because investments are made during periods of both rising and falling prices, the average purchase price of an asset can be lower than in the case of a one-time purchase, especially when the market is volatile. As a result, the investor does not overpay by buying assets at too high a price, but also does not miss the opportunity when the price is low.
Example:
- Month 1: BTC price = $50,000, you buy 0.002 BTC for $100.
- Month 2: BTC price = 40,000 USD, you buy 0.0025 BTC for 100 USD.
- Month 3: BTC price = USD 60,000, you buy 0.00167 BTC for USD 100.
In total, after three months, you have 0.00617 BTC for $300, which gives an average purchase cost of $48,625 for 1 BTC, even though prices fluctuated between $40,000 and $60,000.
Avoiding emotional investment decisions
One of the biggest enemies of an investor is emotional decision-making. When the market falls sharply, many investors panic and decide to sell their assets to minimize losses. This mechanism is widely known, but have you ever wondered where it comes from? Yes, it’s time for a bit of biology in an article about investing.
Why Emotions Influence Investment Decisions? An Explanation from the Perspective of Human Brain Operation
The influence of emotions on investment decisions has its roots in the biology and evolution of the human brain. Our brain is a complex organ that has evolved over millions of years to help us survive in an environment full of threats. One of the key areas of the brain responsible for emotional reactions is the limbic systemand especially amygdala (amygdala).
The role of the limbic system
The limbic system is the brain’s emotional processing center. When faced with a potential threat, such as a sudden drop in the value of an investment, the amygdala activates the “fight or flight” response. This response, once essential for survival in the wild, causes our bodies and minds to react quickly to sudden changes in our environment. In the context of investing, this can lead to an impulsive decision to sell assets to “escape” the risk of loss.
The role of the prefrontal cortex
In turn, another part of the brain, prefrontal cortexis responsible for more complex thinking, analysis, and long-term planning. This is the area that allows us to make rational decisions, considering different scenarios and potential outcomes. However, when the amygdala is overstimulated by stress and fear, it can dominate the decision-making process, “switching off” the more rational thinking of the prefrontal cortex.
Investors’ emotional dilemma
As a result, during periods of strong market volatility, many investors may make decisions under stress and fear, leading to actions such as panic selling of assets. Such behavior is typical during financial crises, when many people “follow the crowd,” which can deepen market price declines.
Dollar-Cost Averaging (DCA) counters this by allowing investors to stick to a set plan and regular investments, which reduces the influence of emotions on decisions. Systematic investing in accordance with DCA allows investors to focus on long-term goals rather than the momentary emotions triggered by market volatility.
In this way, DCA not only helps you build an investment portfolio, but also helps you deal with the natural emotional reactions that can sabotage your investing efforts. Because this strategy limits the influence of emotions, investors can make more informed and effective decisions.
How to start DCA with Binance?
Binance, one of the largest cryptocurrency trading platforms, offers tools to help you implement a DCA strategy. To get started, you need to create an account on Binance from this link . Our guide can help.
Then, select the cryptocurrency you want to invest in and go to the Auto-Investments page. There you can set the amount and frequency of your investment. Setting up recurring orders will allow you to automatically make purchases according to a set schedule. This is a convenient solution that allows you to implement a DCA strategy without having to place orders manually.
Summary
Dollar-Cost Averaging is an effective way to reduce the risk associated with investing in volatile markets such as cryptocurrencies. Regular, consistent investments allow you to build a portfolio without having to speculate on future price movements. DCA is also a way to avoid emotional decisions that often lead to losses. If you are a beginner, DCA is a simple strategy that is easy to implement on platforms such as Binance.
