Cashing out - the ultimate risk-off move?

peter-siks
Peter Siks

Summary:  From time to time in your investing journey, you might want to reduce your risk. The simplest way to reduce your market risk is by being less invested in the market. You can achieve this by selling some or all your positions aka cashing out. While it might make sense to reduce your exposure by selling positions, there are important considerations you need to be aware of before you make the move.


Exposure possibilities

When you buy stocks, bonds or any other financial instrument, you expose yourself to market risk. You probably do this to earn a positive return and make money. Imagine you have EUR 10,000. If you choose to invest the full amount, this is known as being fully invested (all your capital is on the table). You have created maximum exposure. High rewards are possible but there is also significant risk.

You could also choose to only invest a portion of the 10,000 or not invest anything at all. With the former, you are partially invested and with the latter, you are not invested at all. When you aren’t invested, you have no market risk but also no potential to gain when markets go up.

Reasons to go cash

Over time, markets tend to go up. But there might be times when you feel uncomfortable with how the markets are moving or you think that the valuations are too high given the economic outlook. In such cases, you might choose to reduce your exposure by selling all or parts of your portfolio and have more cash at hand. The benefits of that move include:

  • Less exposure thus less risk and for some less stress
  • The ability to act on opportunities that may arise along the way
  • The ability to cover margin requirements when you invest in derivatives such as options, futures or CFDs.

Put another way: the stronger you believe markets will go up, the more you tend to be invested. Following that line of thinking you should decrease your exposure if your conviction declines

How to go cash

There are many ways to reduce exposure. You can reduce exposure in increments or be more drastic and sell it all at once. You can choose to act immediately or act only as a result of a defined event using conditional orders.

  1. Cut your positions. This approach leans on the belief that if you are not comfortable, you should reduce your exposure. It’s important to understand that with less exposure you limit your losses but you also limit your potential to gain. For example, with a 50% exposure reduction if markets go down, your loss will be halved but if markets go up, you can still generate a return. Whether you reduce your current positions by 15%, 50% or more depends on your conviction, or worries, about the current market. 

  2. Apply stop-loss ordersA stop loss does exactly what the name evokes, it stops your losses at a pre-set level you choose. For example, let say you own shares of company ABC currently priced at EUR 20. If you don’t want to lose more than 10%, you could place a stop-loss order at EUR 18 (20-2). Stop-loss orders are placed at the position’s level which means that if you own 100 positions, orders should be placed for each one individually. Additionally, stop-loss orders aren’t guaranteed at the price you specify. When markets are volatile, prices can move below the price you set and your order will be executed at the next available price which might be substantially lower. 

  3. Apply (trailing) stop-loss orders. A trailing stop-loss order is similar to a stop-loss order but in addition, it locks in profit when prices go up. If company ABC goes up from EUR 20 to 30, the trailing stop-loss moves with the new price. So if you don’t want to lose more than 10%, the trailing stop would be EUR 27 (30-3) and not 18 which is the stop loss at a price of EUR 20.

  4. Use the account value shield protection mechanism. With the value shield protection, your positions will be liquidated if the value of your account reaches a certain (lower) level. For example, if you have a portfolio worth EUR 40.000 and you don’t want to lose more than 10%, using the account shield value protection means that your positions will automatically be sold when the portfolio value reaches EUR 36000 (40000 - 4000). The shield is only activated when losses occur not when your portfolio rises in value. The shield is similar to a stop loss at the portfolio’s level. Note that this mechanism isn’t available on SaxoInvestor Platform and does not apply to bonds and mutual funds positions

As you can see, there are several ways to reduce your market risk – going all cash isn’t the only opportunity. The method you choose depends entirely on your view of the markets. If you are completely convinced that everything will fall, you might opt to sell everything. But if you are not so sure that we are on the edge of very strong market decline, other approaches might suit you better.

Cash in your account

So now that you have cash in your account, that leaves the question of what to do with it. Of course, you can just leave it there. Then you will have no market exposure and you can start investing again when you are comfortable re-entering the market. But be aware that inflation is eating away the purchasing power of your cash!

Another possibility is to invest your cash in a money market fund that provides (some) return on your investment, although these can also have negative returns depending on the financial outlook and the currency it is denoted in.

Wrap up

Selling positions and going cash is a simple way to reduce your market risk. There are several ways to reduce market risk and the most radical one is to sell everything immediately. Other less drastic options exist depending on your viewpoint of the current market environment. Once you have a (maybe even 100%) cash position, it is clever to weigh the possibilities that exist to put that cash position to work in the lowest risk environment possible via e.g., a money market fund.

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