Dollar Cost Averaging in cryptocurrency
I wrote a small (~200 lines of code) Command Line Application which allows you to buy a basket of cryptocurrencies from Kraken: https://github.com/vicsn/krakentrader. This makes it easy to frequently invest small amounts of money into cryptocurrency.
Disclaimer: this is not investment advice. Use this application at your own risk.
Why dollar cost averaging?
It is hard not to pay attention to the current cryptocurrency frenzy. Two widely used approach for non-professional cryptocurrency investors are:
- Approach (1): either buy varying amounts at various moments in an ad-hoc manner, based on a fundamental belief in the value of cryptocurrency, or at least, in the belief that others believe in the value of cryptocurrency.
- Approach (2): or both buy and sell at a more frequent basis, thereby trying to beat the market.
Without additional assumptions, I don’t think either strategy is fundamentally better than the other, but I do think it useful to understand the different types of risk and assumptions of each approach.
If you follow approach (1), you are betting on a single or small amount of data points: the price will be higher at some point in the far future than it is now. However, even if you are correct in that bet, you still risk gaining very little. With the last major financial crisis already 12 years in the past and asset prices soaring, your investment may lose all of its value in an economic downturn.
If you follow Approach (2), you are betting every time that you buy or sell. This has a higher potential upside than approach 1 as every single upswing or downswing can generate a profit) but also higher potential downside (as every single upswing or downswing can generate a loss). Making money on the stock market as an individual trader is hard, there have been numerous studies showing that a random walk can be as effective as investment funds. Now, there may certainly situations where traders may be able to beat the market, but it seems likely that those do require significant investment, of time and/or capital: “His huge victory reminds us of the clearest example of how finance professionals can perform better than random chance: cheating, loopholes, and investing in ways impossible for the rest of the market to match.”
There is a third approach, namely the one that many people already follow for their pensions:
- Approach (3): buy fixed amounts on a frequent basis. If you follow this approach, you are placing many small bets that the value of the stock of your preference goes up. The name for this investment strategy is called Dollar Cost Averaging.
With my new tool, the third approach should be easy to implement if you've use Command Line Applications before. If not, I recommend you to email your preferred cryptocurrency exchange and to ask them about how to place periodic orders. When a trading platform charges a fixed fee per trade, this may not work well. Fortunately, several cryptocurrency trading platforms only charge fees as a percentage of the money you’re spending, making this approach worthwhile!