Impossible Finance -“Cost Averaging Down”

The idea of cost averaging down is an idea commonly propounded by those encouraging investment in highly speculative investments, typically those that have been falling in value for a long period . The following is a quote from a cryptocurrency forum

I invested initially from savings with a large first buy at .86 I have now managed to cost average down to .68 and hold a pretty big stack of XRP. I am currently 60% down on investment but it doesn’t bother me because I am playing the long game. Remember you only lose/ or win when you sell. XRP in my opinion is a fantastic investment and one I am happy to be in.[i]

The basic idea is that falling prices are a good thing because they provide the opportunity to buy more of an asset at a lower price, reducing the average price paid per unit. The example below is of someone “cost averaging down” by buying $5000 periodically of a cryptocurrency called Ethereum. In addition to getting a bargain (because if it was a great investment when the price was higher, it must be an even better investment when the price falls) it is supposed to put the investor in a better position when the price finally rises to its true value.

Figure 1 — Delusional View of Investment

Persuaded? Feel like investing in an asset that has seen a prolonged full in value because everything bounces back eventually and “cost averaging down” is a great way to prepare?

Well let’s look at those numbers again but through the eyes of a conventional investor. Marking the investment to market (multiplying number of units held by the current price) shows a progressively increasing unrealised loss. To use a more apt investment metaphor the investor is “catching a falling knife”.

Logical View of Investment

“Cost Averaging Down” is clearly not a great investment strategy, unless the asset really is an under-appreciated gem. If as explained in a previous article, the investment is a cryptocurrency, it is fundamentally without value and market forces will continue trying to drag it towards fair value i.e. zero.

The motives for thinking this way are fairly clear. Investors who have lost a great deal of money have a crutch to lean on to help them psychologically cope. Typically this is combined with the expressed belief that you only lose money when you sell an asset. However, there are motives other than personal delusion. If you are a large holder of an asset or even more likely someone that makes money selling cryptocurrencies, the last thing you want is people to sell. The longer people cling to their falling asset and ideally add to their holding, the greater your opportunity to profit by selling.

One of the tools fraudsters use, is to take the language and symbols of conventional investment and use them to make highly speculative assets or Ponzi-like schemes seem more legitimate. Superficially “Cost Averaging Down” seems superficially similar to an investment technique called “Dollar Cost Averaging”. Dollar Cost Averaging suggests the best way to deal with market volatility when investing, is to drip feed in fixed proportions of a lump sum rather than make a single investment. A plausible sounding strategy though one refuted by the analysis in some papers, that suggest Dollar Cost Averaging generates lower returns.[i]

So is cost averaging down a sensible approach for investing in highly volatile assets such as cryptocurrencies? Undoubtedly no, like so many things associated with the cryptocurrency world, another example of Impossible Finance.

[i] https://personal.vanguard.com/pdf/ISGDCA.pdf

[i] https://www.cryptocompare.com/profile/Eclipse/#/activity