As a trader, having the discipline to not be invested is a game-changer.

After all, you need to have cash on hand to take advantage of new opportunities. You can’t “buy the dip” like I’ve been saying for weeks without it!

Despite it being one of your most important trading tools, having dry powder is often overlooked.

I believe differing timeframes and individual risk preferences are to blame. 

Yet the fact remains that many investors misunderstand the role cash plays in their portfolios.

So today, I’ll explain why having cash on hand is a must. I’ll also show you when you should use it and how.

But first, let me clarify a few key differences between trading and investing…

Trading vs. Investing

Here at Paradigm Press, part of my role is to share my trading strategies with our readers. What do I mean when I say “trading”?

My definition of the term is that we are looking for shorter-term opportunities (six seconds to six months) and looking to make money in EVERY type of stock market.

Investing, in contrast, is longer-term (years and decades) and focused on maximizing returns.

Stocks seldom double in six days, six weeks, or six months. If you own a stock in your investing portfolio for six years and it hasn’t doubled… you should probably sell it!

For your investing portfolios, I am a strong believer that you should always remain mostly invested.

While you may be able to time the stock market as a trader, it is not necessary (or optimal) for investors. For most of them it will destroy value.

What do we mean by this? How do you incorporate it into your strategy?

“Sell High, Buy Low”

Every trading strategy is different, but most can be boiled down to the common sense advice to “buy low and sell high.”

The proprietary software system I use for my flagship trading service The Maverick identifies opportunities based on the movement of individual stock prices.

At its most basic level, this system looks for companies with strong operational momentum with stocks that have been big winners.

I then look for entry points where those stocks have sold off to an interesting level — when investors have sold the stock down so far and so fast that it is highly likely to snap back.

The system generates a ton of extremely attractive signals when we see steep selloffs like the one we experienced over the past month. Outside of broad market selloffs, we also get a lot of signals around earnings season.

In these moments, we become more aggressive and expand the number of recommendations. (This is when it’s time to put your cash to work.)

But if the market is not doing very much, then the number of ideas just depends on what is happening at the company level.

On the flip side, the number of recommendations decreases as the stock market recovers.

In fact, we often get very few signals when the stock market is at its highs, regardless of company-specific news.

The rising tide of the market lifts all shares, and very few companies — especially winning ones — are oversold.

This means our number of actionable recommendations falls. At this pint, we are taking profits on existing positions while not finding a large number of new ones (building our cash reserves).

To put this into numbers, we average 20 open recommendations at any time in our model trading portfolio.

The number of open positions can fall to low single digits at stock market highs versus the high 20s during selloffs.

I don’t run this model on a specified amount of theoretical capital. But I like to think of it as a 100% invested portfolio at its averages (each of the 20 positions would be a 5% allocation).

Our Secret Weapon

As the stock market recovers, so does our trading portfolio’s cash balance.

For instance, if there are only seven positions, then we would be only 35% invested. This means that we would be holding a 65% cash position.

This cash is the result of our “sell high” discipline.

We are happy to be in this position because it means that when the stock market sells off, we can execute our “buy low” strategy.

Usually, we will approach the 75% to 100% invested position via 15–20 positions as the markets test their 50-day and 100-day moving averages.

If it goes much further, we are willing to apply leverage and go to as much as 150% invested (30 positions) to take advantage of the situation.

This is how our cash position is our secret weapon!

It gives us the ability to turn the volatility and market risk into our advantage.