Cut Your Portfolio Heat: Cash Is King, Not Gold | MartinKronicle - Michael Martin
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Cut Your Portfolio Heat: Cash Is King, Not Gold

Nasdaq100

Nasdaq Composite - They Don't Always Come Back (click to enlarge)

When your portfolio heat is too high, cut the risk and go to cash.

When world markets start to fall, investors sell indiscriminately. Fear takes over, and they just sell to get out and go to cash because the uncertainty in the markets has become unbearable. When the level of portfolio heat rises (what traders call the risk in their portfolios) cut your position sizes by a large margin or cut them out altogether.

Conventional wisdom dictates that you be diversified, but when everything is going down and you’re not short, all diversification does for you is ensures that you only have a percentage of the worst loser.

Case in point: last week gold and copper got killed, the US dollar rallied, fears of financial collapse in Europe (the Euro), there was a worse-than-expected US unemployment number, there are fear about China, and the US stock markets fell and were very volatile and your portfolio probably showed it. In Europe, the debt levels of Greece, Portugal, and Spain are dominating the tape. All you need is one of them to fail or default for there to be a global sell off.

Which came first? How do you protect yourself (your capital)? The answer is “it’s hard to tell.” That’s why many traders enter what are called protective Stop Orders to buy or sell in advance of bad news hitting the ticker tape. Investors can do it too. If your portfolio is entirely long (you own things), the benefit of entering such orders is that you’ve picked an uncle point to go to cash well in advance of the market getting killed. If it begins to sell off due to any number of factors, you’ll be liquidated and your assets will be better preserved in cash until things cool down: you’ll be better able to read and digest the information with a clear head and cool demeanor by being in cash.

Market Timing Is A Good Thing

You don’t need another idea to invest in before you divest yourself of an investment in your portfolio. Risk management is just that – managing risk. It’s not holding on to some loser, researching another potential investment (from the same place that gave you the first loser), and trying to make a decision on when and how to make the switch.

When markets are in turmoil, many things that are not normally correlated become so. That means that the US dollar, gold, bonds, and the stock markets can all do against you at the same time and for longer periods of time than you can imagine they can. Therefore, cash is king – especially in this economy and real estate market.

The USD, gold, and the Euro are inversely related, so if the fear of Spain collapsing led to vigorous selling of Euros, then the USD could have easily rallied, tanking gold with it. Copper was taken out back and shot which could be related to the fears about China or floor creep from the Gold pits. Floor creep occurs when there is massive price moves up or down in one pit, and it “creeps” over to another pit on the floor.

If the US economy continues to falter, you’ll feel much better in 6-12 months by having been in cash during that time than having not been. You’ll have a higher account balance although it’s in cash, than 12 investments that become highly correlated.

Look at the charts below of the Dow Jones Industrial Average and the COMEX Gold and compare them to the Nasdaq 100 Composite above. (click to enlarge)

S&P500

S&P 500 Index

Gold

COMEX April Gold

Your Emotions Affect Your Judgment About Money

Another very important aspect of doing this is you will take the emotion associated with the paralysis of watching the market on TV and not knowing what to do. You won’t go to bed crushed that you’ve lost a great percentage of your assets in the market and for realizing that diversification has done nothing for you to preserve your wealth or trading capital. Having more cash means you’ll have more choices. You can always get back into the market or any trade.

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  • irondoor

    If market timing is good enough to tell you to get out of your coordinated longs, isn't it good enough to tell you to get short? Not necessarily everything you sold, but you can take some positions on a relatively small risk scale with put options. Assuming, of course, that you get paid if everyting goes to hell. Cash = T-bills.

  • martinkronicle

    I agree. Some investors/traders are afraid to sell short – that was my
    point.

  • mksandiego

    Excellent points. I noticed in Sept-Nov 2008, as the stock market plunged, gold and bonds were definitely not safe places to park.

    I would imagine cash would not be king if the market “turmoil” was the dollar collapse. What are your thoughts on the safe havens in a hyperinflation scenario?

  • martinkronicle

    Besides gold, silver, food, and potable water, I'd feel comfortable with a Sig Sauer P229 9mm and a Benelli M4 or Mossberg 590A1 12- gauge tactical shotgun.

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  • I'm going to track the performance of the points given here and see if in the future i can actually make some money.

  • martinkronicle

    :) Keep in mind, my blog insights about markets are more about
    /falsification/ and playing good defense than making market calls. My
    blog posts aren't trade recommendations for you to make money. If I did
    feel a need to do that, I'd probably join the club at StockTwits for
    example.

    With that in mind, I feel that the world is raising cash right now b/c
    they are in great fear of the markets and the global banking system.
    Trends in everything in the near-term might go out the window when a great many of market
    participants offset their positions.

    Lastly, I never have a position in anything I blog about so I will never
    have any conflicts to disclose.

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  • I'm going to track the performance of the points given here and see if in the future i can actually make some money.

  • martinkronicle

    :) Keep in mind, my blog insights about markets are more about
    /falsification/ and playing good defense than making market calls. My
    blog posts aren't trade recommendations for you to make money. If I did
    feel a need to do that, I'd probably join the club at StockTwits for
    example.

    With that in mind, I feel that the world is raising cash right now b/c
    they are in great fear of the markets and the global banking system.
    Trends in everything in the near-term might go out the window when a great many of market
    participants offset their positions.

    Lastly, I never have a position in anything I blog about so I will never
    have any conflicts to disclose.