So you want to start building your Bitcoin position?
How should you go about it? Should you just whack your full investment stake in one go?
In this post, I’m going argue that you shouldn’t just whack it all in, and instead I’m going to argue that you should dollar cost average your Bitcoin investment.
What is dollar cost averaging?
This is a way of building a position and making sure that your overall price that you entered a position isn’t too high. (assuming that you want to go long) or too low (assuming that you want to go short).
Example: buying Rolls Royce stock.
If you have £1,000 that you want to invest (i.e. buy/go long), then you could invest that whole £1,000 into Rolls Royce now. Looking at the price in the chart below, the current price as at 14th August 2017 is 904.50p or GBP 9.045.
Now you could put the whole £1,000 into RR at this price.
But what happens if the price starts to fall in the next month, say it drops to 800p? That’s a drop of 11%?
Well, this sort of thing does happen. 11% lower than you got in for? You’re not going to be happy. You’re going to wish that you got in at a lower price. However, you couldn’t have predicted that the price was going to go down anymore than you could have predicted that the price was going to rise following your purchase. But there is a way that you could have lessened the blow of the price drop:
You could have dollar cost averaged your entry into this position.
The easiest way to see this is to imagine that you split your total investable stake (£1,000) into equal chunks say (four lots of £250) and invest at pre-defined intervals (say £250 every week). In our decline case for RR above, this might look like:
Week one: invest £250 at 904p
Week two: invest £250 at 860p
Week three: invest £250 at 835p
Week four: invest £250 at 801p
First step is to calculate how many shares each weekly investment would buy you, then you add up all the shares you bought to arrive at the total RR shares bought.
Then you divide the total investment made (£1,000), by the total number of RR shares (118).
You get an average price of £8.47 or 847p.
Here’s the steps in spreadsheet form:
So thanks for the maths lesson Chan, why does this matter?
Well, if the price is now at 800p (£8.00), then your loss from your average price at £8.47 is less than it would have been had you gone all in at 904p (£9.04).
Fair enough however, the price might have only gone up from 904p (£9.04), and then you’d be sore that you dollar cost averaged with a rising price, therefore reducing off your gains.
This matters even more with Bitcoin and cryptocurrencies
Smoothing out your entry is even more important when trading in volatile things. In our context, volatility refers to the price movements of Bitcoin and other cryptocurrencies.
Look at the price movement from Bitcoin 2017 to date:
The green line above is the price of Bitcoin in USD. Look at the volatility!
From mid-July 2017 to 15 Aug 2017, Bitcoin has risen from USD 2,000 to past USD 4,000. That’s 100% in a month!
You don’t see moves like that in normal stocks like Rolls Royce above.
This extreme of move plus the speed of the move is why dollar cost averaging is so important when building your Bitcoin position.
So if you have £10,000 to invest in Bitcoin (going long), don’t just pump it all in at today’s price. Split it into four £2,500 chunks and invest these in weekly intervals over four weeks and see what your average price for your Bitcoin will be.
Let me know how it goes in the comments below!