This way you could stand a better chance of profiting from volatility
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Those who held Bitcoin and other cryptocurrencies in their investment portfolios for the last six months have experienced a range of emotions - from the euphoric highs of Dec. 2017, when the price of Bitcoin almost blasted through the $20,000 barrier, to the crashing lows of Feb. 2018. That’s when this article was written and although now, when the market has entered the green light, it might seem a little irrelevant, we all know about the potential for enormous volatility that lies ahead.
It’s important to note that this article should not be taken as investment advice and that you should always remember the golden rule of investment: never invest more than you can afford to lose.
Assuming the cryptocurrency market capitalization were to maintain a long-term upward trajectory forever, it would make sense to never sell your coins—presuming they have strong fundamentals—by “HODLing” them indefinitely.
However, if there’s one thing cryptocurrency investors have learnt this winter: it’s that sometimes it pays to take profits, which can then potentially be used to buy back into the market later when prices are lower. The problem, of course, is knowing when to take out profits and when to buy back in.
Technical analysis strategies involving the study of price and volume patterns of charts can work well here, but they require skill and practice to master. On top of this, charts can be interpreted differently depending on the analyst - what looks like a sell signal to one may appear as a buy signal to another. This room for interpretation may also open the door for emotional biases when analysing the charts, meaning sometimes investors see the patterns they want to see.
What is Value Averaging?
Value Averaging (VA) is an alternative investment strategy that investors have been using in the stock market for years. It tends to work better for investments that are highly volatile in the short term, so it could be a good fit for cryptocurrencies. The idea behind VA is to:
Buy more coins when they are cheap (at good value).
Buy fewer coins when they are expensive (at worse value).
Sell some coins when they are really expensive (at terrible value).
The overall result of this is that investors lower the average prices at which they buy coins and raise the average prices at which they sell them.
VA case study:
Say you have $100 worth of Bitcoin today and you want that value to increase each month going forward in increments of $100. By the time next month comes around, the price of Bitcoin has been cut in half - meaning your starting $100 investment is now worth $50. To get the value of your investment up to $200 in the second month, you must now make up the difference by buying $150 worth of Bitcoin. Because the price is so low, you end up purchasing more Bitcoin for that $150 by taking advantage of the sale.
Now suppose that by the time the third month starts, the price of Bitcoin has gone up a bit. Your $200 investment is now worth $220. To get that value up to $300 in the third month, you therefore need to invest another $80. In this scenario, you buy less Bitcoin than you did last month during the sale.
By the beginning of the fourth month, the price of Bitcoin is up significantly. Your $300 investment now stands at $500. Since you only need $400 invested in the fourth month, you sell $100 worth of Bitcoin to lock in some profits, which means your investment is now more protected if the price drops next month. Since you still own some Bitcoin, you would also profit if the price goes up next month instead.
The disadvantages of VA
An obvious pitfall of VA is that the price of the investment could keep going down each consecutive month, resulting in larger monthly payments by the investor. By the time the year is over, investors could end up spending more than they had originally intended. One way to offset this risk could be to set a yearly maximum spending limit. Going back to the earlier example, you could for instance set this to $1,200 for the year.
In this case, $1,200 would be the same amount you would have spent over twelve months by using a simple Dollar Cost Averaging (DCA) strategy, in which you always invest $100 each month regardless of the price of Bitcoin.
Like VA, DCA also averages the prices at which investors buy their investments, however unlike VA, DCA doesn’t tell investors when to sell and take profits. For example, when Bitcoin was climbing towards $20,000 in December last year, DCA investors would have bought more Bitcoin while VA investors would have been forced to lock-in some profits.
As compared to HODLing - either through DCA or by investing a larger amount all at once - you could end up owning fewer coins further down the road with VA. If those coins increase in value over the years, your cryptocurrency portfolio could be worth more by HOLDing.
However, nobody knows what’s going to happen tomorrow, so it’s better to be safe than sorry by selling some coins when prices are high and buying more coins when prices are low. This way, you could stand a better chance of profiting from volatility - something we can all be sure of with cryptocurrencies.