Dollar-Cost Averaging for Cryptocurrency Portfolios (2020 Update)
Dollar-cost averaging (DCA) is a strategy used by investors to reduce downside risk of placing large sums of money into the market at one time.
While this can be in the form of purchasing a single asset on a regular interval, we will be focusing on the strategy from the portfolio perspective. Considering it as a way to regularly inject new funds into a portfolio.
A dollar-cost averaging strategy will effectively distribute the injected funds across the portfolio based on a set list of target allocations.
How it Works
To better understand this strategy, let’s break down each of the steps which take place during a dollar-cost averaging event.
Deposit Detection
DCA will execute only when a deposit is detected. On a regular 15-minute interval, we can evaluate if new funds have been added to the portfolio. Once a deposit is detected, a DCA is triggered.
Upon the time of deposit detection, we will record the amount of the asset which was deposited. The DCA will only use these deposited funds to execute trades in the following steps.
Note: Executing trades on the exchange outside of Shrimpy is considered a deposit for the traded assets. This will trigger a DCA! If you plan on trading directly on the exchange, disable DCA until at least 15 minutes since your last trade.
Allocating Funds
Now that the deposit has been detected, we will take the funds which were deposited and evaluate how to distribute them for the dollar-cost averaging strategy. No other assets or funds will be moved during the execution of the DCA.
Based on the current allocations of our portfolio and the corresponding target allocations, we can calculate how much of the deposited funds should go to each of the assets in the portfolio to reach our target allocations.
Note: It may not be possible to reach our target allocations with the deposited funds. In this case, we will distribute the funds proportionally to the amount which is owed to each asset. For example, if we have 4 BTC to distribute but two assets which require 2 BTC and 3 BTC respectively to reach their target allocations, we will distribute 2/5 x 4 = 1.6 BTC to the first asset and 3/5 x 4 = 2.4 BTC to the second asset.
Trade Execution
Once the desired trades have been calculated, each individual trade will be executed to build the target portfolio. Any funds which are left over at the end of the DCA due to failed trades or minimum trade limits will be left in the deposited asset.
Example
To provide an example of how DCA works, let’s walk through a portfolio simulation.
Imagine we have a portfolio worth $100. This portfolio currently holds an even distribution of 5 different assets such that each asset has a value of $20 in the portfolio. Therefore, we could also say the portfolio has currently allocated 5 assets at 20% each.
The portfolio would look something like the following:
Pre-DCA Portfolio: Asset Values
Now, let’s imagine we are depositing $100 more into this portfolio and want the funds to be dollar-cost averaged into the portfolio. If the target allocations are 30% BTC, 25% LTC, 20% ETH, 15% XRP, 10% BCH, then the result of the dollar-cost averaging after the deposit would be the following portfolio.
We see most of the funds are distributed to BTC to make up for the amount required to reach it’s target allocation of 30%. At the same time, no BCH was bought during this operation because it was already at its target allocation.
Notice how we didn’t simply take the target allocations and use these percentages to distribute the funds (such that BTC would get 30% of the new funds, LTC would get 25%, and so on). Instead, the funds were added such that at the end of the operation, the portfolio was as close as possible to the target allocations.
How Is This Useful?
Dollar-cost averaging is a portfolio strategy which allows for the immediate detection and distribution of funds into a portfolio. The funds are distributed in a way which they work to reach the target allocations of each asset in the portfolio.
Note that dollar-cost averaging is NOT a rebalance. Only the funds which were deposited are traded during a dollar-cost averaging event. The entire portfolio may or may not reach their target allocations. It’s quite possible the portfolio has deviated far enough that a dollar cost average wouldn’t allow for reaching the target allocations.
Reduced Trade Frequency
Traders which are conscious of the number of trades they are making now have a strategy where they can reduce the frequency of their trade execution. This can potentially reduce the number of taxible trade events, eliminate the necessity for some rebalancing events, and maintain a balanced portfolio during periods where new funds are deposited.
Trading Fees
With frequent deposits, it may be possible to replace some rebalances with dollar-cost averaging events. This can reduce on the fees experienced during rebalances, curtail the movement of funds back and forth between the same assets, and help construct a holistic portfolio strategy.
Set It and Forget It
As with most strategies we focus on, DCA is another way to simplify your life. No need to fumble around with manual trading, executing threshold rebalances to attempt to simulate DCA, or manually trading. Simply set your DCA and automatically allocate your funds upon each deposit.
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