The Most Underrated Trade: Cash
Traders like to trade. It’s what we live for. Whether we’re going long or short the market, trading the next 5-minute candle or the next 5-year economic expansion, each of us has unlimited opportunities to make money. Five days a week, between the hours of 9:30AM and 4PM EST.
Whereas most people consider work actually doing something, traders have a choice—I would even say obligation —to sometimes do nothing. Absolutely nothing. No trades. No scalps. Just sit in cash and let everyone else trade.
“What are we waiting for?” Is my favorite question among newer traders. “The market is rallying. We should be in stuff.” I’m sure that in those moments they see me as the laziest bum in the world. I get it. The day opens in a buying frenzy and we’re just sitting still. This was the most frustrating thing to me when I started out. I was here to make money, and if I wanted more I thought I had to do more.
But like people, the market has different moods. Whether your strategy is day trading, swing trading, or long term investing, not every market mood will suit your bottom line. And in times of uncertainty, cash is king.
Here are some signs you are trading when the market mood isn’t optimal for you:
You’re working harder, but making less money
Trades are hitting your stops quicker than usual
You’re stressed out
When we trade in market conditions that don’t suit us, we lose our money. Warren Buffet once said, “The stock market is a device for transferring money from the impatient to the patient.” He was referring to being patient in a trade, but I would say it also applies to being patient out of a trade—and sitting in cash.
Trading is not just about making money, it’s also about keeping it. When the market comes under pressure, becomes volatile, or has extremely over-bullish readings with low put-call ratios (see below), I’ll start scaling out and moving to cash. It’s saved my hard-earned profits, over and over again.
The times to move to cash are when:
Major indices begin to come “under pressure” (see IBD definition)
Volatility is increasing (the VIX is generally greater than 20, see below)
Put-call ratios begin reading less than 0.85 (signals “over bullishness”, see below)
Volatility Index (VIX) vs. S&P 500
Put-Call Ratio vs. S&P 500
Below is a chart displaying the changes in a real trader’s account balance over several days in the market. He traded appropriately (Point 1 and 2), but decided later to continue trading as he had as the market was changing moods (Point 3). As a result, he lost 30% of his recent profits.
Trader Account Balance vs. S&P 500
Here’s exactly what happened over the course of two months (this is a real account):
Part 1. Market found support at 2600, and trader opened long positions.
Part 2. Market couldn’t break 2750 resistance, VIX and Put-Call ratios still relatively normal. Trader reduced risk, took some profit, and suffered only a minor balance drawdown ($108,000 to $102,000).
Part 3. Market signaled short-term “over-bought” conditions according to put-call ratio (<0.85) and stalled at prior 2,800 resistance. Trader’s account balance reached all-time highs ($134,000). Trader does not take profits or adjust to these new market conditions, and continued to trade as before. Account balance drops 30% from $134,000 back to $106,000 in the following week.
Believe me when I say, working hard to do nothing is really hard. But we have to do it. The news, the analysts, the mob mentality to take trades and win big are all just distractions from what really matters. Don’t trade just for the sake of playing the game.
Ignore the FOMO suckers, wait until the deck is hot, and cash in all your chips.