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Smart DCA: Smart Dollar Cost Averaging
Investing smart via Smart DCA uses a trading strategy that tries to improve DCA (periodic investing) by better timing buying and selling moments. This gives historically improved results, especially in a declining market.
Thriven has made it possible to periodically and automatically invest in crypto via Smart DCA. This article explains how smart investing works via Smart DCA and how you can start building a portfolio from €0.
Prefer direct information via an intake?
Schedule a free intake with Meyade of 15 minutes and find out more about Smart DCA via Thriven.
Prefer direct information via an intake?
Schedule a free intake with Meyade of 15 minutes and find out more about Smart DCA via Thriven.
Index
- What is Dollar Cost Averaging
- How does DCA work
- What are the benefits of DCA
- The risks and disadvantages of DCA
- DCA in different market conditions
- What is Smart Dollar Cost Averaging
- How does Smart Dollar Cost Averaging work
- What are the advantages of Smart DCA
- What are the risks of Smart DCA
- Smart DCA in different market conditions
- For which assets is Smart DCA applicable
- How much and how often must be deposited
What is Dollar Cost Averaging (DCA)?
Dollar Cost Averaging (hereinafter DCA) is an investment strategy in which an investor regularly invests a fixed amount of money at fixed times, regardless of the price of the asset in question (e.g. stocks, Bitcoin or gold).
The concept of DCA probably grew out of a desire to reduce the impact of market volatility on returns. The term “Dollar Cost Averaging” was first used in the United States in the 1950s or 1960s, hence the reference to the dollar. However, the concept of DCA works the same regardless of the currency used for the recurring investment.
Over time, the concept of DCA has become increasingly accepted and recognized as an effective investment strategy. Today, many professional investors and financial advisors recommend using DCA as a way to reduce the impact of volatility on investment returns.
How does DCA work?
DCA works by regularly investing a fixed amount of money, regardless of the current price of the investment in question. For example, if an investor decides to invest $500 each month in a particular stock, then the investor will invest $500 each month regardless of whether the stock is currently worth $50 or $80.
This way, the investor will automatically buy more shares when the price is low (because $500 will yield more shares at a lower price) and buy fewer shares when the price is higher.
Over time, the investor will obtain an average cost per share that is lower than if the investor had invested all the money at once at a specific point in time.
What are the benefits of DCA?
In addition to the lower average cost per asset, DCA can help prevent emotionally led investing. Regularly investing a fixed, small amount teaches the investor not to react to short-term fluctuations in the market. As a result, the investor will be less inclined to panic and make bad investment decisions.
Due to the simplicity and periodic nature of the strategy, DCA can help investors self-discipline and achieve their long-term investment goals.
What are the risks and disadvantages of DCA?
Unfortunately, there are no profitable investment or trading strategies that are risk-free or perform the same in all market conditions. This also applies to DCA.
- DCA doesn’t work in a falling market. If the price of the investment continues to fall over a longer period of time, when DCA is applied, the average cost per share will actually be higher than if the investor had invested all the money at a later date at a lower price.
- DCA can under some market conditions lead to a situation where an investor buys at high prices all the time and never takes advantage of low prices. This situation is known as “Dollar Cost Ravaging”.
- DCA asks the investor to make a long-term commitment. If an investor decides to stop the strategy after a short period of time, he/she may miss out on potential profits.
- DCA is less effective in a market that is constantly rising (i.e. without dips or temporary downward price movements). Under these circumstances, the investor buys at a higher price each time, resulting in a higher average cost per asset compared to a one-off purchase at the start of the investment period.
DCA in different market conditions
As can be seen in Figure 1, DCA pays off particularly in a rising market. Due to the periodic deposits, the value of the investment (orange line) is less volatile than the price of the underlying asset (grey line).
The gray vertical stripes represent the buying moments.
As long as the value of the investment is above the total invested capital (black line), there is a positive return on the total invested capital. Under declining market conditions, it can be seen that DCA loses much of the accumulated return. In the above period, the final return is even negative due to the long-term fall in the price of the assets in question.
What is Smart DCA?
Smart Dollar Cost Averaging (hereinafter SDCA) is an automated trading strategy from Thriven based on the same concept as DCA (periodic investment), which aims to improve the performance of DCA in a declining market. The biggest difference with DCA is that with SDCA both buying and selling takes place. This makes SDCA a trading strategy and not an investment strategy.
Since SDCA is a trading strategy, it is not strictly necessary to invest periodically. However, without a periodic investment, many of the advantages of DCA are lost, which means that there is more chance of volatility in the return achieved over time.
How does Smart DCA work?
SDCA falls into the category of so-called “trend following” strategies. These are strategies where a trader opens positions in the direction of an existing market trend, with the aim of profiting from this trend.
As with the DCA strategy, SDCA assumes a periodic investment amount (eg $500 investment on the 1st day of each month). However, where the DCA strategy uses the periodic deposit directly to buy assets, SDCA takes the current market trend into account to determine the moment of purchase. As a result, the deposited amount may not be used immediately to buy. This is especially true during a falling market.
In addition to timing buying opportunities, the SDCA strategy also uses the current market trend to determine suitable selling opportunities. Through an automated process, all owned assets are sold at a time of sale. Selling assets is especially useful when the trend is changing from rising to falling. The funds released after the sale can be used at a later time to purchase assets.
Just like ‘ordinary’ DCA, SDCA can buy a maximum of 1x per period, but unlike DCA, this is not mandatory. Since assets can only be sold when assets are owned, SDCA can only sell once per period.
What are the advantages of Smart DCA compared to DCA?
Unlike DCA, SDCA only buys during a rising market. If the trend changes from rising to falling, SDCA will sell the assets it owns. As a result, especially in a declining market, (much) less value is lost compared to DCA. This ensures that SDCA, especially for assets that experience both rising and falling market situations, has a high chance of outperforming DCA.
In addition to this benefit, SDCA retains all of the stated benefits of DCA. Due to the simplicity and periodic nature of the strategy, combined with the automated buying and selling process, SDCA can help investors achieve their long-term financial goals without the stress of manual trading.
What are the risks of Smart DCA compared to DCA?
- Like DCA, SDCA can under some market conditions (particularly during a flat market) lead to a situation of consistently buying at high prices and never taking advantage of low prices. Because SDCA can also sell assets and there is therefore a chance that not only buying but also selling times are sub-optimal, the impact of this risk is greater than with DCA.
- SDCA tries to improve buying opportunities compared to DCA. As a result, SDCA sometimes purchases at a later time than DCA. In a constantly rising market, SDCA will therefore perform relatively worse compared to DCA.
The performance of any investment or trading strategy depends on market conditions and will therefore need to be constantly adjusted to maintain optimal performance over the long term.
Smart DCA in different market conditions
Just like DCA, SDCA mainly yields in a rising market, but as can be clearly seen in figure 2, SDCA loses much less investment value (orange line) under downward market conditions than DCA.
The dotted vertical lines represent the sales moments.
In contrast to DCA, SDCA achieved a more than positive return in the relevant period, in contrast to DCA, which closed the same period with a negative return (see figure 1).
How to start from €0
For which assets is DCA / Smart DCA applicable?
DCA and SDCA can be applied to a wide variety of assets, such as stocks, bonds, precious metals or crypto. Both strategies are best suited for assets whose price can be volatile, i.e. prices can rise or fall relatively quickly.
Because each asset has its own market characteristics, SDCA must be tuned per asset. This is done periodically through an automated solution based on AI techniques that has been developed in-house at Thriven. This solution ensures that the strategy continues to perform optimally even under new market conditions.
DCA and SDCA are both good strategies for investors who don’t want to worry about the “right” time to get in or out of certain assets. They are particularly suited to avoid emotionally led investing and force investors to focus on investing regularly rather than trying to find the perfect entry or exit point on their own.
How much and how often must DCA and SDCA be deposited?
A monthly deposit is a common choice because it offers a good balance between regularity and flexibility. A fixed monthly contribution also fits well with the fact that most people receive their monthly salary.
The periodic investment amount and the duration of the investment horizon are also important factors that must be taken into account when determining the right frequency for a DCA strategy. Both factors should be aligned with each individual investor’s financial situation, whereby the periodic deposit is responsibly portable for the relevant person during the entire investment period.
An initial investment is not necessary, but if applied must be in proportion to the periodic investment. If the initial investment is many times higher than the periodic investment, then the effect of the periodic investment on the total development of the return is much smaller. A (large) initial investment also increases the chance of an initial large loss (in a declining market) which cannot or can hardly be made up within the set investment horizon.
More information via an intake?
Schedule a free intake with Meyade of 15 minutes and find out more about Smart DCA via Thriven.
More information via an intake?
Schedule a free intake with Meyade of 15 minutes and find out more about Smart DCA via Thriven.
Disclaimer
It is important to remember that DCA or SDCA does not guarantee positive returns. Please bear in mind that investing and/or trading involves a risk and you may lose (part of) your investment. It is therefore important to consider your own financial situation and investment goals and to consult with a financial adviser before deciding on the size of the initial or periodic investment amount for any individual investment or trading strategy.
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