Trading Rule – “Sitting on too much cash is never a great idea

WHEN SHOULD A TRADER IDEALLY SIT ON CASH? OBVIOUSLY THERE ARE NO EASY ANSWERS TO THIS QUESTION. IN TIMES OF VERY HIGH VOLATILITY IT DOES NOT MAKE SENSE TO TRADE AGGRESSIVELY AND YOU MAY CHOOSE TO SIT ON CASH. BUT ONE OF THE UNDERLYING RULES OF TRADING IS THAT THE MORE YOU SIT ON CASH THE LESS MONEY YOU MAKE IN TRADING. THAT IS BECAUSE TRADING IS ESSENTIALLY A GAME OF ROTATING YOUR MONEY AND PLAYING THE MARKET BOTH WAYS. BY SITTING ON CASH YOU ARE LOSING OUT ON THE BASIC PREMISE OF TRADING

WHAT IS THE BIG IDEA OF SITTING ON CASH AS A TRADER?

It is said that there are three decisions in the market viz. when to buy, when to sell and when to do nothing. Doing nothing is also equivalent to sitting on cash. There are times of market uncertainty when the markets may be too volatile to trade with a stop loss and profit target. These are brief periods when it makes sense to sit on cash. But when you sit on cash there is a cost to it in terms of lower returns and also in terms of insufficient churning of capital. The whole idea of trading is about rolling your money to make the best of opportunities both ways in the market. As long as it is possible to take a view, one can always adjust the stop loss and profit targets and trade accordingly. It is only it times of extreme volatility and uncertainty that it makes sense to sit out of the market altogether. As a trader, sitting on cash is not a strategy at all. It is an approach that should be used by the trader only in the rarest of circumstances.

AS A TRADER YOU CAN ACTUALLY PLAY ALL KINDS OF MARKETS

AS a trader in the stock market you are not just limited by equity products but also have access to futures and options. The advantage here is that you can use limited risk approach of buying options when the market is too volatile. Similarly, if you want to take a view on volatile markets without worrying about direction then you have strangles and straddles that can help you do the job. Also if you are expecting a range bound trading then there are opportunities in the form of spreads where you can trade for limited profit and limited risk. The idea of trading is all about using your capital innovatively to make the best of the prevailing circumstances. The use of futures permits you to trade the markets both ways in a leveraged manner and so you are indifferent to the direction of the market as long as you are able to catch the underlying trend perfectly. In fact, even in dull markets there are option selling strategies that you can deploy that can help you to earn steady returns with limited risk. The moral of the story is to keep churning your money and putting it to work.

“Instead of trying to predict what will happen to the market just look at what is happening in the market and play along” – Market Wisdom

6 REASONS TO AVOID SITTING ON CASH FOR TOO LONG

  1. When you sit on cash for too long you are defeating the basic premise of trading which is to put your money to aggressive use. The whole idea of trading is to churn your capital aggressively so that the ROI is expanded. The crux of trading is that you target around 2% ROI per week and use a mix of strategy and discipline to repeat this performance as often as possible. If you sit on cash then you are not losing money but then that is not the reason you became a trader in the first place.
  2. Like it or not, money has an opportunity cost. There are various reasons for that. You may have borrowed that money from someone and you are paying interest on that. You need to earn returns to service that cost. Alternatively, this money may be your own funds but then own funds also have a cost just as equity has a cost. You cannot ignore this cost and if your cash idles then you are losing out on opportunities and could have possibly put your money to better use.
  3. Trading is not only about strategy and discipline but it is also about habit. You need to get habituated to thinking and behaving like a trader. By sitting on cash for too long you are going to lose out on being a successful trader by practice. The more you trade, the more you will learn along the way and a better trader you become eventually.
  4. The biggest cost in trading is loss of opportunities. When you sit on cash you miss out on a plethora of opportunities. You may miss out on shorting opportunities, you may miss out on volatile strategies and you may miss out on defined limit strategies. Sitting on cash is idling your trading skills and has a huge cost which you must appreciate.
  5. The real capital in trading is the initial capital multiplied by the velocity of circulation. So if you have a base capital of Rs.5 lakh and you leverage it to 5 times and you churn the capital 20 times in a year then your actual capital is Rs.5 crore. This kind of virtual leverage is possible only if you put your money to constant use. By idling your money you are losing out on your potential virtual capital.
  6. Sitting on cash for too long may make you a conservative trader. That means you actually lose out on the variety of opportunities in the market. Also, the merits of sitting on cash can be quite comforting as you do not lose money and that can induce you to increase the tenure of cash holding. That is anathema for a trader whose primary focus should always be to churn money and tap opportunities in the market.

SO, MAKE YOUR MONEY WORK HARD AND KEEP LOOKING FOR IDEAS

The beauty of trading markets is that you keep tapping opportunities in all kinds of markets. The key is not let your money idle for too long. In trading, sitting on cash is not a strategy at all! Rather it is the absence of trading strategy.

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