Stock Exchange: How Much Cash Are You Keeping On The Sidelines?

The Stock Exchange is all about trading. Each week we do the following:

  • discuss an important issue for traders;
  • highlight several technical trading methods, including current ideas;
  • feature advice from top traders and writers; and
  • provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review: Are You Staying Sane In This Crazy Market?

Our previous Stock Exchange asked the question: Are staying sane in this crazy market? We noted that a conundrum of competing factors were making near-term trading conditions challenging and and in some cases unhealthy. And when the market gets wild, it’s more important than ever for traders to remain level-headed. Taking some chips off the table can be an important risk management technique, depending on your style and goals. This week’s topic is closely related.

This Week: How Much Cash Are You Keeping On The Sidelines?

There are almost as many different viewpoints as there are market participants when it comes to the question of how much cash to keep in your account. One big differentiator is often whether you’re a very long-term investor or a short to mid-term trader. Very long-term investors generally (but not always) like to stay fully invested (0% cash, at least none in their investment accounts, anyway) and simply try to ignore short-term volatility. They believe this can help avoid opportunity costs and inflation risks. However, one notable long-term investor exception is the renowned Seth Klarman of Baupost Group. According to a recent Rupert Hargreaves article, you need to get used to holding cash:

“Klarman likes cash because it offers optionality. He has said in the past that it is his favorite investment hedge because unlike other hedging instruments, it does not cost money to hold cash and there is no chance of unforeseen losses if the market turns against you.”

Traders generally have a much different viewpoint on cash (they’re generally content to hold more cash, more often). For example, trader Joe Fahmy explains why it makes sense for traders to hold some cash:

“During market corrections, you should have at least some of your money in cash in order to protect your capital, to protect your confidence, and to have some money available in case the market continues lower.”

Regarding our own trading models, we will exit all open positions and move to all cash when near-term market conditions are not favorable. And as we noted last week, based on the signal from our models, we exited all of our trading positions in the Athena, Felix and Road Runner models. To be clear, this step is a risk control measure rather than a prediction of the market going down. These models have not yet reentered any positions, but will be getting back to the market when conditions are better. And as a reminder, our Holmes trading model did not move to all cash because of its independent set of requirements and stops (basically, Holmes can take care of itself).

Model Performance:

We are sharing the performance of our proprietary trading models, as our readers have requested, as shown in the following table:

We find that blending a trend-following / momentum model (Athena) with a mean reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.

For more information about our trading models (and their specific trading processes), click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.

Expert Picks From The Models:

Note: This week’s Stock Exchange is edited by Blue Harbinger, a source for independent investment ideas.

Holmes: I sold my position in Ubiquiti Networks (UBNT). I purchased shares last week, and sold this week at a slightly higher price.

Blue Harbinger: Ubiquiti is involved with equipment and software services. According to their website, the company is focused on “democratizing network technology on a global scale.” They’ve shipped nearly 85 million devices that play a key role in creating networking infrastructure in over 200 countries and territories around the globe.

Holmes: Thanks for that information, but as you know. I am a technical trader that likes to buy the dips. I am not a long-term investor.

BH: I do know that, but I thought you might also like to know that the company has been growing earnings in recent years, and it has been beating street revenue estimates in recent quarters. 

Holmes: Thanks for that information too, but do you realize that as a buy-and-hold investor, your results are basically at the mercy of Mr. Market?

BH: I can appreciate your differentiated strategy, Holmes. It can be very helpful to have a strategy with lower correlation to the overall market. But by the way, don’t you usually hold for about 6-weeks. Why’d you only hold UBNT for a week?

Holmes: I have an independent set of requirements and stops, and I exit my positions when market conditions warrant. 

BH: I see your strategy has been doing relatively well compared to the S&P 500 for example. Anyway, how about you, Felix–any trades to share with us this week?

Felix: I recently exited all my open positions as a precautionary risk management move. Market conditions have gotten a little crazy. I will wait for things to settle down again before my next trade. However, I did run the S&P 500 constituents through my model, and my top 20 rankings are listed below.

BH: Thanks for that info, I appreciate rankings, but remind us–what is your trading style?

Felix: I am a momentum trader. I typically hold for around 66 weeks. I use stops and pay attention to macro conditions for risk management reasons. And as you know, I just exited all my trades because near-term conditions have gotten a bit unhealthy. Again, not a bet on market direction–just risk management.

BH: Okay. Thank you for that. And I see GE on your list. After a terrible 2018, that one just had a big day on the first trading day of 2019. Perhaps some of those tax loss harvesting sellers of 2018 were re-entering their positions. Anyway, how about you Oscar? As our resident ETF trader, do you have anything to share?

Oscar: Yes. This week I ran our “High Liquidity ETFs with Price*volume over 100 million” through my model, and the top 20 are ranked in the following list.

BH: Interesting. And remind us, what is your trading strategy?

Oscar: I am into momentum. I typically hold for 6 weeks, and then I usually rotate into a new sector or style ETF.

BH: I see you like Germany (EWG) and Home Builders (XHB). Thanks for sharing, Oscar. I’d ask Athena and Road Runner if they have any trades to share, but I already know what they are. Like Felix, they just exited all of their open trades because near-term trading conditions are not healthy for their technical models. Which is fine, because I know they’ll be back when conditions settle down–it’s all part of their process.

Conclusion:

How much cash you should hold depends on a variety of factors including your goals, your strategy, your tolerance for volatility and current trading market conditions. For example, when things get volatile, it can be wise to exit your trades and keep more cash on the sidelines, particularly when market conditions aren’t as conducive to your trading strategy. Cash can be an outstanding hedge against unexpected market declines, and it gives you buying power when conditions warrant re-entry.

Stock Exchange Character Guide:

StyleAverage Holding PeriodExit MethodRisk Control
FelixNewArc StocksMomentum66 weeksPrice targetMacro and stops
Oscar“Empirical” SectorsMomentumSix weeksRotationStops
AthenaNewArc StocksMomentum17 weeksPrice targetStops
HolmesNewArc StocksDip-buying Mean reversionSix weeksPrice targetMacro and stops
RoadRunnerNewArc StocksStocks at bottom of rising rangeFour weeksTimeTime
JeffEverythingValueLong termRisk signalsRecession risk, financial stress, Macro

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome. Your can also access background information on the “Stock Exchange” here.

Trade alongside Jeff Miller: Learn more.

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