Dollar-Cost Averaging: Benefit from Volatility
Dollar-cost averaging provides investors a tool with which they may use volatility to their advantage. Properly employed, the process offers benefits for buyers and sellers of traded assets ranging from stocks to bonds, cryptocurrencies, sports bets, and collectibles. Trading costs, both in terms of effort and commissions, mark drawbacks to the method.
In purchasing or selling assets at various points in time and at various prices – the procedure described by dollar-cost averaging – market participants with longer term perspectives may manage short-term market dynamics. Consider the following example:
- An individual investor wishes to purchase 1,000 shares of stock in a biotech company, we’ll call it Hypothetical Biovations (HYPO for short),
- Hypo will announce its quarterly earnings before the market opens in three days, and
- Management may (or may not) provide positive (or negative) results from a clinical trial for one of Hypo’s new drugs on their earnings conference call at 10:30 AM ET, an hour after trading opens for Hypo shares.
Our HYPO investor incurs several risk-points in pursuing their biotech investment, such as:
- Overall stock market volatility (beta) that may drive changes in HYPO share price irrespective of any specific company phenomena,
- Aversion or affinity within the investment community for the Healthcare sector or Biotech subsector of which HYPO is a member,
- Analysts’ analysis and opinions on the probability that HYPO will miss, meet, or exceed their expectations for the company’s quarterly results and/or future performance, and
- Views within the HYPO investment community on the potential success, or lack thereof, of the company’s new drug.
Utilizing dollar-cost averaging to potentially manage through this litany of risks – the other side of which are opportunities – might involve our HYPO investor buying a one-quarter (250 shares) position prior to any company-specific events. For the sake of adding specificity to our example, let us assume HYPO shares trade for $10 each upon our investor initiating their position for an outlay of $2,500.
Subsequent to this initial purchase, one of HYPO’s sell-side analysts decides to downgrade HYPO shares from Buy to Neutral a day prior to the company announcing quarterly earnings. In response HYPO shares trade 10% lower to $9 per share. The investor picks up another 250 shares at this $9 figure, resulting in a weighted-average price of $9.50.
Exacerbating this downside momentum, a day later HYPO just meets expectations for its quarterly financial performance. Also, management chooses not to mention any new drug developments in its earnings press release: shares give up another 10% and trade to $8.10 after the markets open. Our investor – eyes on the long-term prizes they expect HYPO to offer – picks up another 250 shares at $8.10 per share, bringing their average cost to $9.275 per share.
An hour later in management’s commentary concerning future prospects for HYPO, they mention the positive clinical trial results that our investor thought might materialize on the call. Shares on this news shoot 10% higher than their $8.10 low to $8.91 per share. Our investor rounds out their 1,000-share position at this $8.91 per share price, bringing their weighted average price per HYPO share to just over $9.00 (see table below).
Hypothetical Investment in Hypothetical Biovations (HYPO)
| Shares | Price | Incremental Investment | Total Position Average Cost | |
| Initial Trade | 250 | $10.00 | $2,500.00 | $10.00 |
| Trade #2 | 250 | $9.00 | $2,250.00 | $9.50 |
| Trade #3 | 250 | $8.10 | $2,025.00 | $9.03 |
| Trade #4 | 250 | $8.91 | $2,227.50 | $9.00 |
We’ll provide a positive ending to our HYPO example. Sell-side analysts’ upside revisions that incorporate their more robust expectations for HYPO’s new drug cascade through the market. As a result HYPO’s share price moves through the $10 level, leaving our investor with a tidy $1,000 profit vis-à-vis their $9.00 dollar-cost average-driven average weighted price as well as the $10 figure at which they initiated their position
Of equal potential value for investors considering employing dollar-cost averaging in their efforts, the method works for exiting positions as well. To illustrate this simply replace the “buy” related verbs in the above paragraph with “sell” verbiage: the figures remain the same. While our example employs a relatively short time frame of several days, driven by a specific event, the principle defining the prospective value of dollar-cost averaging in to or out of tradeable assets typically works over a wide range of timeframes and market conditions.