Terms Of The Trade: Dollar-Cost Averaging

Investors who are bullish on a particular stock over a long-term period could find the concept of dollar cost averaging (DCA) of use.

Specifically, DCA refers to an investment strategy in which an investor buys a fixed dollar amount of a particular stock (or ETF, commodity, etc.) regardless of its price. When the stock is trading at a lower amount, the investor obviously buys more shares, and when the stock is higher the investor buys less shares.

Over time, the investor builds a sizable position in the stock and manages to do so at a lower average share cost.

Example: Bullish On Groupon

Suppose an investor is bullish on Groupon Inc (NASDAQ: GRPN), the online marketplace that connects merchants with consumers by offering their products at a discount.

Investor sentiment has been rather poor, as the company's business model, margins, not to mention the growing competitive landscape, has affected the company's stock — which traded north of $20 per share in 2012, but flirted with the $2 level in 2016.

Related Link: Terms Of The Trade: Earnings Per Share

However, suppose an investor held a long-term bullish view on the stock a year ago. The investor would have assumed that a turnaround is in the works, and the company could better monetize its large and growing customer base.

Given the stock's volatility over the past few years, the investor deems it unwise to go "all-in" and make a one-time large purchase of the stock. In this case, the investor decides to make use of the DCA concept and buy $1,000 worth of shares on or around the 15th of every month at its opening price.

Here is what would have happened:

• August 17, 2015: Bought 230 shares at $4.33.
• September 15, 2015: Bought 243 shares at $4.11.
• October 15, 2015: Bought 274 shares at $3.64.
• November 16, 2015: Bought 387 shares at $2.58.
• December 15, 2015: Bought 323 shares at $3.09.
• January 15, 2016: Bought 375 shares at $2.66.
• February 16, 2016: Bought 303 shares at $3.30.
• March 15, 2016: Bought 245 shares at $4.07.
• April 15, 2016: Bought 225 shares at $4.43.
• May 16, 2016: Bought 294 shares at $3.39.
• June 15, 2016: Bought 314 shares at $3.18.
• July 15, 2016: Bought 282 shares at $3.54.
• August 15, 2016: 174 shares at $5.74.

The investor would have made 12 separate purchases, bringing the total holding to 3,669 shares at an average price of $4.005 per share. On the other hand, the investor could have spent the same $12,000 and bought 2,771 shares on August 17, 2015 at $4.33.

Groupon's stock opened for trading at $5.53 Wednesday morning.

Granted, under both scenarios, the investor would be making money today. However, the level of profit is much higher by through the DCA strategy, which allowed the investor to take advantage of price dips throughout the year.

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