When the weight of the evidence is pointing in one direction as it has been from early 2016 through mid-2018, 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 mixed, a more neutral approach is appropriate. So 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.
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 direction or another.
For the last two months we’ve been approaching the market from a more neutral stance given the cracks we were seeing in the major indexes, Financials, Small-Caps, and other leaders like Energy, Fast Moving Consumer Goods, and IT.
At current levels it’s tough to press shorts and difficult to get long with leaders breaking support and mean-reversion trades not confirming.
Last week we outlined what we need to see in terms of market internals to define our risk and get more aggressive on the long side, but we’re not there yet. While some trades like PTC Inida Ltd. have worked, the number of quality setups on both sides of the tape is low.
Click on chart to enlarge view.
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 or using strength to lighten up on longs or add shorts, having the flexibility that cash has provided over the last 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!