Dollar Cost Averaging, or DCA for short, is an investment strategy.
It’s also called a constant dollar plan. It’s different from a forex trading strategy because it’s about how a trader manages money for long term investment purposes.
Money management is often a neglected part of an FX trader’s arsenal. And a good investment strategy can be a helpful complement to a good trading strategy in order to improve profitability.
So is DCA for you?
What Is Dollar-Cost Averaging?
Simply put, it’s when an investor makes regular investments in a target asset at specific, pre-defined intervals.
The objective is to reduce the impact of volatility in the overall purchase. The practical upshot of this is that by buying the asset at a specific time instead of price, it removes a lot of the work related to trying to time the market to get the best price.
In other words, the investor splits the amount of money they have to invest in certain amounts and then buys into the market regular intervals, say each month.
A classic example of this plan is retirement funds like 401(k). With that, the investor deposits a certain amount each month with their paycheck.
Investing and Profiting
As you can see, the purpose of this strategy is to build an investment portfolio over time, ideally without withdrawing until the investments have matured.
It’s different from a strategy where the FX trader wants to make money with their portfolio and spend it immediately. DCA is the preferred strategy for long-term investment, especially for people looking to build capital for (early) retirement.
DCA intends to take advantage of the ups and downs of an asset as it trends higher over time; it doesn’t insulate the investor from long-term losses.
This is why it’s a preferred strategy for stock investing, especially with indexed funds.
Indices have traditionally always trended higher (with corrections during periods of recessions), which is different from other assets that fluctuate or even trend lower, such as bonds.
The Cost Basis and Retail Trading
Remember, dollar cost averaging is an investment strategy, not a Forex trading strategy.
It won’t help you decide whether or not to get into a certain currency pair. However, it’s useful to consider when deciding how to fund your trading account.
Saving up to make a one-time, lump-sum investment means that you lose out on the growth potential in the time that you aren’t actively investing.
By making smaller, regular contributions to your portfolio, you average out the ups and downs of the market, reducing the risk that the lump sum might be done just as the market is about to change direction.
Getting the Most out of Your Money
Even if you plan to invest in a trading account as a way to generate an income, you still have to grow your portfolio so that it has a rate of return and capital buffer sufficient to be able to withdraw funds without negatively impacting your trading.
So, at least initially, DCA would help speed that process along.
In general, DCA reduces the cost of buying into the market. So over time, investments that grow will see a larger return on investment, while investments that go down will see a lower loss.
During the period of growing your portfolio, making regular, manageable contributions to your trading account can help improve your profitability.