The Hardest Trade to Make Right Now

21%… That’s how far the small-cap Russell 2000 Index has fallen in the last month.

It’s a glimpse at how much hurt has been put on small-cap investors during this broad market sell-off. Don’t think that bigger stocks have been spared – the S&P 500 index is down more than 15% over that same period.

#-ad_banner-#Buy-and-hold investors are getting battered out there right now.

And it’s not just them. Some of the biggest (and most well respected) hedge funds on Wall Street are getting hammered in August, with names like SAC Capital and Paulson & Co. posting large losses on the month. Banks aren’t immune either – Goldman Sachs also recently admitted that deteriorating trading conditions were to blame for its recent bout of lackluster performance.

At the same time, one simple trading plan would have spared you from the carnage. But I’ll be the first to admit that it’s the hardest trade you could have made…

Let me explain.

There’s a misconception among new traders that you have to be doing something all the time. Whether the market’s going up, down, or sideways, these guys want to be executing trades. But that approach to trading can be absolutely toxic to your portfolio. In times like these, you have to remember that cash is a trade.

That’s right. By sitting out of the market when risk-reward doesn’t synch up, traders not only take advantage of small gains from interest rates, they also increase their risk-adjusted returns by decreasing their market exposure. That’s a crucial element to longevity in the market.

Being all cash isn’t the same thing as being gun-shy about your trading. When the market’s out of alignment, you need to approach a cash position as an active position just like any stock or option you buy. Contrary to popular belief, having a portfolio full of cash is “doing something” in this market.

Part of the reason why cash is such a crucial position to take at times is the fact that markets don’t just go either up or down. Instead, volatile markets (like this one) can easily whipsaw you out of positions as stocks churn sideways. This week is a perfect example of that…

Even though stocks have been pushed much lower in the last month, it’s the volatility that’s a real concern. The S&P rebounded by 4.74% on Tuesday, proving that it’s not a particularly safe market for short sellers either.

The bottom line is this: don’t be afraid to sit on cash when stocks get wacky. I’m advising that my premium readers do the same until the technicals tell us otherwise…