Dollar Cost Averaging Junior- The Short Term DCA
If you just started getting into investing in the stock market, you most likely have come across the concept of dollar cost averaging (DCA). DCA is an investment strategy most commonly used by long-term investors. It is the practice of consistently purchasing additional shares of a pre-existing position in one’s portfolio with the same dollar amount at pre-determined intervals of time (weekly, monthly, etc.). The basic idea is that by purchasing shares at a consistent rate (time) with the same dollar value, one can minimize the volatility of a position because it will be added to on both high and low markets, ultimately averaging out to a competitive/comparable price point per share to the present market.
A shorter term spinoff of the DCA strategy would be to cover positions on bearish days to minimize the overall loss per share in a position. Essentially, when share prices drop one would purchase additional shares at the new, lower price point, so that the average price per share reflects the current market price. Simply put, if I bought a stock at price X and the price drops to Y, I can buy additional shares of the stock at price Y so that the average price of all my shares owned will be Y. The outcome being a net neutral position. You may have technically lost money on your investment in the initial investment when the stock price was X, but through this short-term version of DCA, your position in the stock as a whole hasn’t lost any money overall as you purchased enough shares at price Y to cover the losses.
This short-term DCA, which I referred to in the title as DCA Jr., is an intriguing micro-strategy that can also prove to be a double-edged sword. Essentially this approach can lead you to double down on bad bets, but could also enable you, if lucky, to attain additional shares at discounted prices. However, the former is far more likely.
So unless you are completely sold on a stock you shouldn’t be dollar cost averaging. I’m looking at you penny stock traders! There’s no need to buy-in at $4.00, $3.50, $3.08, and $2.90. If you really believe in the company or that the investment can yield 30-40% returns within a relatively reasonable time frame, then learn to wait. A much smarter way to DCAJr. will resemble the following: $4.00, $2.99, $2.00- maybe even $4.00, $1.75, $.50. Essentially, look to buy-in when prices are dropping at larger margins. Don’t sweat the .5% drops, take aim at more significant price target differentials. Let the market waves do their thing. Patience will provide better buy-in opportunities and/or will help prove certain investments as fundamentally flawed.
Additionally, the volume of shares that you buy/sell at each price point can be an important part of your DCAJr. strategy. When your position starts to bleed, buying-in at incrementally larger positions can prove to be a strong execution strategy. This will help buffer the possibility of missing out on the bottoming of the stock. An example using the price points from above: $4.00 (10 shares- initial investment), $3.50 (2 shares), $3.08 (5 shares), $2.90 (15 shares. In this particular case the DCA would end up being $3.30 per share (32 shares for $105.90). Obviously, no one can predict the bottom-out price of any stock, but depending on the specific stock’s price history, recent company/industry performance, and present market factors, one can make a highly educated guess at which drops in prices might be considered an anomaly or seasonal depreciation. Based on this estimate, one can consider at which prices to buy-in. I’d recommend setting specific price and share targets, and setting limit orders on the positions you are particularly bullish on. Try not to bargain or chase the market around. You’ll just end up with a lot of cancelled order emails/notifications in your inbox and a handful of buy-in misses.
I AM NOT A FINANCIAL ADVISOR NOR AN ANALYST
Happy trading :)