There’s nothing wrong with holding large amounts of cash. In fact, during periods of uncertainty, and during periods of inflated asset prices, cash is KING.

But when stocks are moving higher, everybody wants to ride that train. Folks put all their money into the market. They lever up and borrow money to throw into the market – to the maximum their brokerage firm will allow. Anyone crazy enough to advise holding cash gets ridiculed.

The situation always ends the same way…

Stocks eventually top out. Prices fall. And those unfortunate souls, who borrowed everything they could to ride stock prices higher, start getting margin calls. They have to liquidate their positions at a loss in order to meet their brokerage firm’s requirements. Oftentimes, that means they’re selling stocks near the end of the decline.

Meanwhile, folks who held onto their cash as stocks pressed higher into overbought conditions now have the luxury of buying stocks at sale prices into a declining market.

The story never changes. It repeats itself a couple of times every year.

Yet, even time-tested market veterans have a tough time holding cash. There’s just too much pressure to be 100% invested in a rising market.

I get it. My email gets flooded with complaints every time I recommend caution as the market runs higher and the technical conditions stretch into overbought territory. Folks get disappointed they’re not maximizing the profit potential of the rally. They feel like they’re missing out on huge gains while I’m advising a cautious stance.

But, after trading stocks and options for 36 years, I know this to be true… It’s dangerous to buy stocks into overbought conditions, and it’s dangerous to short stocks when conditions are oversold. In those environments, the safest trade is to be conservative and to hold a large amount of cash.

Think about the situation we faced last January. Stock prices were running higher. The S&P 500 reached extremely overbought territory by the middle of the month.

There was enormous pressure among financial advisors to be 100% invested in order to capitalize on the “melt up” phase of the market.

The S&P 500 went parabolic. The gain was unsustainable. And stock prices collapsed.

By the time the S&P bottomed in mid-February, the index had lost about 10% of its value.

That’s not a horrendous decline. By historic standards it’s relatively mild. But, folks who had leveraged their accounts to the maximum got crucified.

Meanwhile, folks who had cash could step in and buy at sharply depressed prices.

Yesterday, the S&P 500 closed at 2889. That’s right about the same level as the January high. Folks who held the S&P 500 since then are basically breaking even – after suffering through a vicious decline in February. Meanwhile, folks who sat on their cash balances the whole time have earned about 1% in interest payments.

In other words, cash has earned a better return than the stock market over the past eight months. And that return has occurred with far less volatility.

I’m pointing this out today just to highlight the positive aspects of holding cash. It gives traders the flexibility to put money to work during stock market corrections. That’s an advantage you don’t have if you’re fully leveraged into an overbought market.

As we head into the latter half of September – when the stock market typically struggles – having a decent amount of cash on hand should prove to be a good thing.

It will give you the chance to buy stocks at depressed prices in anticipation of a rally into the end of the year.

Best regards and good trading,

Jeff Clark

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