What is dollar cost averaging (DCA)?

Dollar cost averaging (DCA) is a trading method consisting of purchasing a fixed amount of an asset at consistent intervals over a sustained period of time, rather than buying all at once. In theory, applying DCA can reduce the overall impact of volatility on a portfolio and reduce the average cost per unit of the asset being traded. That's because, if executed properly, this method can help the trader buy regularly when prices dip — assuming the market sees both highs and lows. DCA isn't without its tradeoffs, however, and it's important to keep a balanced view on the tactic's pros and cons.

In this article, we'll explore DCA in depth. Our goal is to help you understand what DCA is, how it works, the tactic's advantages and disadvantages, and some key considerations when implementing it.

TL;DR

• DCA involves a trader opening multiple smaller positions at regular intervals rather than committing a single lump sum once. The goal is to reduce the impact of market volatility on their portfolio.

• In theory, DCA could reduce the average cost per unit of an asset because the trader might be buying more of an asset during the dip and less during price spikes.

• DCA is considered a simple trading tactic because it can reduce the need to time the market when accumulating an asset.

• DCA bots are a popular choice to automate the tactic, bringing greater simplicity and reducing the potential for emotion-led decision making.

• Although popular, DCA isn't always the best option. In certain market conditions, it can be less effective than others, and could even lead to missed opportunities. Its long term success relies on the assets' long term price appreciation, which only traders themselves can try to predict.

Why do traders use DCA?

Every trader is unique and driven by their own motivations. However, traders often use DCA for the following reasons.

To manage market volatility

DCA can allow traders to mitigate market volatility by buying more of an asset when prices are low and less when prices are high. This is achieved by opening a consistent position size with each trade. With this approach, traders aim to avoid overpaying for an asset when prices are higher.

To avoid timing the market

Many traders consider DCA to be an effective alternative to trying to time the market, which is especially difficult given the inherent volatility of crypto. Meanwhile, they like that it removes some of the emotional influence involved in trying to find the perfect entry and exit point. Here, sudden spikes and drops in prices can lead traders to take impulsive action, influenced, for example, by the fear of missing out (FOMO).

To simplify trading

Simplicity is another motivation driving many to adopt DCA. Because the tactic involves opening positions at regular intervals and for a similar value each time, you can automate much of the process using trading bots. Bots not only allow you to set the date and time to open a new position at, but also automate the open and close of a position at specific prices. This can remove complexity from your trading strategy and save you time, making life as a trader easier (in theory).

The advantages and disadvantages of DCA

Like any trading tactic, DCA brings both advantages and disadvantages.

Advantages of DCA

• It can make trading more accessible. DCA can help side step much of the complexity involved with other forms of crypto trading because of how rigid it is — open a $100 position to buy Bitcoin on the 25th of every month, no matter the market sentiment. Easy. The hard part is managing your emotions, which leads us to...

• It can promote trading discipline. Many would agree that one fundamental ingredient for trading success is to manage one's emotions. DCA can encourage discipline and better emotional mastery because of the above mentioned rigidity. It can require discipline to continue making buy orders during a massive price correction, for example. Like strengthening a muscle, DCA can help build discipline through repetition and consistency.

• It can potentially lower one's average costs. Because DCA can help traders buy more of an asset when prices are low and less when they're high, they can potentially achieve a lower overall cost per unit for the asset they're trading. This can be rewarding if they plan to hold the asset long-term and if (an important qualification!) the asset rises in value over time. Considering crypto's volatility, none of this is guaranteed to happen, of course.

Disadvantages of DCA

• Traders may miss opportunities in rising markets. One major downside to DCA is that it might not be optimal during prolonged periods of price increases. Here, trading with larger lump sums has the potential to outperform DCA. However, keep in mind that a market upturn can always be quickly reversed.

• DCA sometimes comes with higher fees. Traders can encounter higher fees when using DCA because it typically involves making a greater number of trades at consistent intervals to capitalize on market upturns and downturns. As always, be sure to study the fees of your chosen trading platform before you commit funds to an asset. As the saying goes in crypto, always do your own research (DYOR).

• DCA can be psychologically challenging. That need for discipline we mentioned earlier can take a psychological toll. DCA requires you to sometimes ignore the emotional voice in your head and focus on cold logical thinking to truly see its potential benefits. That's not always easy, especially when price action moves against the predictions you've made through technical analysis. Trading in projects you both understand and have faith in the future of can help you find discipline when it's needed most.

Keep in mind that DCA has a higher chance of being effective in a market with frequent ups and downs, as this cyclical movement can potentially bring the benefit of buying more units when prices fall and fewer units when they rise. Although DCA is a relatively passive form of trading, it's recommended to frequently monitor the market to see if the tactic is best suited to current conditions. For example, during periods of price appreciation, DCA can sometimes leave you with fewer units than if you'd traded a larger sum all at once.

Which traders is DCA right for?

Traders of all experience levels can apply DCA if it suits their own trading strategy.

We've already emphasized how beginners can, in the right circumstances, benefit from the tactic's simplicity. Some crypto trading experts even see DCA as an ideal starting point for inexperienced traders looking to gain exposure to crypto while managing volatility. According to them, by only trading with an amount they can afford to lose and opening positions periodically, beginners can start to understand market dynamics, how news events impact price action, and fundamental technical analysis. DCA can also be beneficial, they argue, to beginners who don't have large sums of money to trade with.

Meanwhile, more experienced traders who are either day traders or trade alongside full-time employment can find a use for DCA in their trading plan, due to the method's efficiency. Some of these individuals may use DCA to accumulate an asset they believe in the long term future of regularly, and potentially at a lower average cost per unit — all without requiring intensive market analysis. In those cases, they enjoy the rigidity of DCA, as it nudges them to stick to their trading plan. Trading bots can be a useful tool in boosting efficiency further by automating some of the work involved in trading with DCA.

How to get started with DCA

Eager to add DCA to your trading strategy? Read on to understand some key considerations to make before you get started.

Set your goals

Like any trading strategy, DCA should start with an understanding of what you're trying to achieve. Are you looking for long-term portfolio growth, and are you ready to commit to DCA for an extended period? Alternatively, are you looking to diversify your existing portfolio with an option that isn't as aggressive and high-risk as other methods? By first deciding on your goals, you can plot a path to achieving them through a carefully constructed DCA plan.

Decide your position size, frequency, and time horizon

With your goals in place, you can build your DCA vehicle by deciding the size of the position you'll consistently open, how frequently to trade, and for how long. To choose your individual position size, it may help to start with a total sum you want to allocate to an asset and then divide this sum into smaller pieces. These pieces become the size of each trade you'll open regularly.

Choose a trading platform

Your choice of trading platform can impact how effectively you apply DCA. We recommend looking for the following characteristics when choosing a platform to trade with.

Low fees

As DCA involves opening multiple positions using smaller amounts, the fees can add up and eat into your potential gains. You can limit this by choosing a trading platform that offers low fees relative to competing options. Virtually all leading platforms will show their fees prominently on the website. Be sure to calculate the fees you expect to accumulate as you work out the total position size you plan to open via DCA.

Automation

The ability to automate your DCA trades using bots can help you to remain consistent and in the best position for potential success. Once programmed, bots take care of the heavy lifting, leaving you with more time for analysis and other trading activities. Specific DCA trading bots are also now offered by various exchanges to optimize the tactic and its potential advantages. We offer three: Futures DCA (Martingale), Spot DCA (Martingale), and recurring buy.

Analysis tools

Although part of the appeal of DCA is its relative simplicity, especially when using bots, that doesn't mean you should set it up and check in only occasionally. It's recommended to frequently monitor the performance of your positions and analyze market movements so you can plan for future trades or take action if the tactic isn't working as expected. Seek out a trading platform that offers a wide variety of tools so you can gather the most insight possible.

Multiple trading pairs

Having access to a large list of trading pairs gives you more options to find the trading opportunities you're confident in. Understand the coins and tokens available across the platform and make sure your platform of choice offers those you're interested in before going through the know your customer process.

Assess and refine

From the start of your DCA experience through to the very end, it's helpful to build the habit of regular assessment, refinement, and if needed, course correction. Although DCA removes some of the intensive technical analysis and deep market analysis necessary with other forms of trading, it's dangerous to be too hands-off. Take the time to periodically assess the performance of your positions in the context of the wider market. If prices are steadily rising and a bull market is locked in for a sustained period, DCA might not be the most effective approach.

The final word

DCA is a common tactic many traders use today with the goal of managing market volatility and reducing its impact on their portfolio. Crypto traders in particular enjoy DCA for this same reason, as the crypto market is significantly more unpredictable than traditional forms of trading.

Traders of all experience levels can try to apply DCA to meet their objectives, and with various tools and bots available today, they can build carefully tailored strategies that include DCA elements. Like all forms of trading, however, DCA requires careful due diligence to define your goals, position size, time horizon, and the best trading platform to meet your needs.