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Bitcoin has come a long way since it dropped below $ 4,000 in March. The cryptocurrency hit a record high of over $ 19,900 early Tuesday and has risen nearly 170% this year.
Although institutional participation has increased, much of the retail clientele may have remained away from the market. For that group, the fear of losing (FOMO) the opportunity for triple-digit gains may have set in in recent weeks.
However, investing now as the cryptocurrency is trading near all-time highs can seem risky because there is always the possibility of a significant price pullback. Bitcoin has seen several pullbacks of more than 20% during previous bull markets.
Therefore, investors looking to buy bitcoin should now consider implementing a dollar cost averaging (DCA) strategy, according to leading cryptocurrency traders.
“It’s a good way to create exposure to both bitcoin and other asset classes such as global equity indices, as both look set to perform well in a context of negative real rates for the next few years,” Scott Weatherill, chief dealer at over-the-counter liquidity provider B2C2 Japan, told CoinDesk.
How averaging the dollar cost can save you money
The DCA, also known as the constant dollar plan, involves buying small quantities of an asset at regular intervals, regardless of price changes, instead of investing the entire amount at once. The strategy helps investors take the excitement out of their trades and can result in a lower average purchase cost because markets rarely move up without pullbacks.
More Info: 5 Reasons Bitcoin Just Hit An All-Time High Price
“The average dollar cost in bitcoin has historically been a very profitable strategy that reduces the risk of drawdown,” Weatherill said.
To illustrate, suppose an investor accumulated $ 100 in bitcoin at the highest price observed on the 17th of each month, starting on December 17, 2017, when bitcoin peaked at $ 19,783. At press time, that investor would own around 0.48 BTC at an average cost of around $ 8,660. It also means that the investor would make a return of nearly 120% at the current market price of $ 18,850.
However, if the investor made a lump sum investment at the record price of $ 19,783 on December 17, 2017, the investment would currently suffer a loss of 4.7%. Over a long period, this loss could be more significant if adjusted for inflation.
In the first case, the investor distributed $ 3,600 over 36 months, buying less bitcoins when prices were high and more when prices were low. This helped reduce the average cost and make a substantial profit. The strategy has produced similar results during previous bull-bear cycles.
“Ideally, you should invest with the hope of selling at higher prices over the long term,” said Chris Thomas, product manager at Swissquote Bank. “The best way, in my opinion, is to buy every month and build a long-term position.”
The risk of some options strategies for retail traders
Some investors may consider implementing synthetic strategies through the options market, such as buying a put option versus a long position in the spot market. The put would gain value in the event of a sell-off, mitigating the loss (on paper) in the long spot market position.
However, such strategies are more suitable for speculators who intend to profit from short-term price volatility and are opposed to the idea of reducing the average purchase cost through DCA. “I would not recommend buying puts if you are ‘DCAing’, as it will aggravate returns,” Weatherill said.
A put option is a derivative contract that gives the buyer the right but not the obligation to sell the underlying asset at a predetermined price by a specified date. A call option gives the right to buy.
An option buyer must pay a premium upfront while taking a long call / put position. A long put position gains only if the asset stabilizes below the strike price of the put on the day of expiry. Otherwise, the option expires worthless, causing a loss – in this case, the premium paid – for the buyer.
Read more: Bitcoin Price sets a new high of $ 19,850
Additionally, those looking to combine DCA with options hedging could end up damaging their portfolios. For example, if an investor buys puts as the DCA and the market goes up, the options bought to hedge against a potential downturn would bleed money, reducing overall returns from the dollar cost average.
“Retail investors should stay away from options trading,” Thomas warned. He added that one particular strategy, selling out-of-the-money calls, is extremely dangerous.
Experienced traders often generate additional income by selling call options well above the current bitcoin spot price and reaping rewards in the hope that the market does not rally above the level at which the bullish bet is sold. However, with short call positions, holders can theoretically suffer unlimited losses because the sky is the limit for any asset.
In the case of bitcoin, this is particularly risky as sentiment remains bullish, with analysts expecting a continued bull run on growing institutional demand. As such, selling call options during DCAing could prove expensive.
“While there may be temptation to optimize through various trading strategies, new money should stick to safe strategies: 1) stay long and 2) buy dip,” said Jehan Chu, Hong Kong co-founder and managing partner. blockchain investment and trading firm Kenetic Capital.
