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Cash on the Sidelines, How Much Do You Need?

by | Nov 27, 2019 | blogs, Editorial | 0 comments

Have you ever heard any of these phrases tossed around:  “we are due for a correction any day now.”  Or “we are due for red after 10 black spins in a row” at the roulette wheel. 

Of course, there is a hint of truth to them. And  As extended the moves in the stock market have been lately, history has proven it’s hard to predict tops and bottoms. 

That’s why I always keep some cash on reserves. 

It allows me room to make adjustments to my option trades, as well as, take advantage of new opportunities that arise. 

How much cash do I keep on the sidelines? And when do I know when to start putting it to work?

 

Keeping Cash On Hand

 

It should not come as a surprise to hear that every investor has different ways of selecting stops and target thresholds for their trades.  Just like traders have varying pain tolerances for losses, many differ when it comes to exactly how much cash to keep on hand. 

The Securities and Exchange Commission dictates that pattern day trading accounts must require two days for money to settle prior to placing another trade.  

 

This means that retaining enough of this asset in an account is important.  Especially if you are waiting for trading capital and miss the trade in that stock you spent all week looking for.

This brings up a good question…

Should you be 100% invested in the markets? Well, the answer is not a simple yes or no answer.

Yes, you should be invested 100% into assets that are going to make you money.  

It boils down to making money with your money that is invested. Is it possible to predict with 100% guarantee what assets will always make you money?  No way!  

So it’s theoretically impossible to invest 100% into assets that are going to make you money all the time.  Remember that some trades will be winners and some will be losers. 

That’s one reason why I never keep 100% invested in the markets.  I never know with 100% certainty what is going to make me money.

Cash is your #1 asset in your account.

 

Diversification

 

While I never know what is going to make money on a daily basis, it’s imperative that I keep all of my investments diversified.  Diversification is the key to capital growth and wealth preservation for any investor.

It’s important to maintain a balanced portfolio of assets.  Just as I do with my real estate business, the investment business should be diversified as well.  When investing in stocks, if one asset doesn’t make money then another can offset it in order to maintain a steady stream of income.

 

Market Timing and Opportunity

 

As my trading account grows in value, a close eye is required to watch over my various positions.  Even with the markets at all-time highs, my options portfolio is generating income for my account. But this doesn’t mean there are some profits left on the table.  

Fun fact:  Warren Buffet has long been an advocate for holding cash and has hinted that he maintains a minimum of $20 billion in his cornerstone portfolio of Berkshire Hathaway Inc. 

When you maintain cash in your account you set yourself up for the next trading opportunity.  

 

The Right Opportunity

 

There is one distinct advantage to holding cash.  That is being able to pounce on any given opportunity to make money.

Since I am an active investor, it is important that I keep cash available at all times.  During any given day I never know what will happen in the markets. Keeping cash free for trading allows me to take advantage of a sudden market opportunity that may come along.  

This is also true in my other real estate business.  I can think of numerous times when seemingly out of nowhere the perfect house was up for sale.  If I had not kept cash available, I can guarantee that I never would have the opportunity to make some of my best real estate sales.

 

Position Adjustments and Dollar-cost Averaging

 

Another benefit of holding cash is the ability to dollar-cost average your trade prices.  

Many times when I enter an investment I am unsure whether or not it is going to be profitable.  Truthfully, there are many investments that actually go against me from when I initially place the trade.

Here is a sample trade for GOOGL  

GOOGL:  Iron Condor Defense Rollout:  Sold the Nov ’19 $1300/1310 CALL spread for $.90 with 3 contracts to create our Iron Condors on our Nov ’19 put spreads.  We rolled these out in Nov ’19 to the Mar ’20 $1360/1380 puts spreads for an additional $.30 credit.

In this trade, I initially placed a trade on GOOGL using put spreads.  As the stock continuously went sideways and slightly against me, I finally needed to make some adjustments.

The first adjustment made was to turn the put spread into an iron condor by selling a call spread.  

The second adjustment made was to get extra time for the initial trade by rolling out the put spread to Mar ‘20 for an additional $0.30 credit.  

The key benefit of dollar-cost averaging is that I ultimately had the ability to add sizing and adjust current trades.  In addition to having the ability to generate increased revenue, I was also able to reduce risk on my position.  

None of this would have been possible if I kept 100% invested with no cash reserves for changes to my trades like this.  

 

Reducing volatility

 

While holding cash in a portfolio may reduce returns as markets continue higher, it may also serve as an anchor to limit losses during declines.  

What happens if a fully invested portfolio goes through a market sell-off?

It’s safe to assume the worst outcome.  A 20% market decline in a fully invested portfolio results in a loss of 20%. 

But what happens if we held 20% in cash?

By reducing market exposure to 80% with a 20% cash position, the same market loss results in a portfolio loss of 16%. 

This means that the right amount of cash held in a portfolio differs depending on investment objectives and risk tolerance.  For myself and many wealthy investors, taking less risk is always better for their business.  

Having a cushion of cash may also provide peace of mind during market sell-offs.  By staying calm and maintaining focus during periods of elevated volatility, you can stay alert to new buying opportunities as panic-based selling begins.  

 

Key Takeaways

 

  • Holding cash as a position provides benefits for aggressive traders and investors with less tolerance for risk.
  • Aggressive traders can take advantage of opportunistic purchases, while others can dollar-cost average.  
  • Cash holdings can make periods of high volatility more tolerable by reducing swings in the value of trading account.
  • Cash holdings allow for adjustments to trades in order to maximize returns or reduce risk when possible.  

If you’d like to start receiving my alerts and begin trading alongside my portfolio (the same one which has had four straight months of winners) then click here to get started today.

 

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