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The Role of Cash in Portfolios – Investopedia

When the weight of the evidence is pointing in one direction, as it has been for most of the past two years, it makes sense to be aggressive and take advantage of the clear trends while they're intact. However, when conditions change and the evidence becomes more mixed, a more neutral approach is appropriate. But what does that look like from a practical sense?
There are several ways to express a shift in bias from bullish to neutral, including tightening stops, being less aggressive on the long side, owning put protection and many others. One of the simplest ways is to raise cash.
In late September, we outlined what the market would have to look like for us to shift to a more neutral bias, and those conditions have played out since then. As a result, an increased cash position during this period of market volatility has served two important purposes.
First off, having a higher cash position allows you to manage risk by avoiding a portion of the downside price action. Getting out of your current positions (if they’re in liquid, public markets) doesn’t cost you much more than the commission to execute the trade and provides an immediate source of portfolio protection when the stock market is falling.
The second reason is that raising cash allows you to be more flexible with your portfolio. Whether you're switching from neutral to bullish or bearish, you're going to need capital to put to work when conditions shift in one direction or another.
[For more tips on tailoring your trading strategy to current market conditions, check out my Technical Analysis course on the Investopedia Academy.]
Yesterday was an interesting day in that many of the major indices gapped down and reversed to close nearly flat and above their early October low. If we see upside follow-through, that would confirm the potentially bullish divergence we’re seeing in breadth as fewer stocks make new lows or hit oversold conditions. However, if we see these potential bullish breadth and momentum divergences fail by prices getting back below today’s low, that will likely set us up for further downside toward the Q1 lows.
Regardless of the outcome, our neutral approach allows us to be ready with a plan for any situation. Whether you’re playing the market on the long side for a bounce, using strength to lighten up on longs or add shorts, and/or using a break of the recent lows to add or press short positions, having the flexibility that cash has provided over the past few weeks allows you to approach the market from a position of strength.
For now, we’re happy to be patient and wait for quality reward/risk setups to develop. Remember, there are no called strikes on Wall Street.
Thanks for reading, and let us know your thoughts!
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Joseph Muongi

Financial.co.ke was founded by Mr. Joseph Muongi Kamau. He holds a Master of Science in Finance, Bachelors of Science in Actuarial Science and a Certificate of proficiencty in insurance. He's also the lead financial consultant.