Cash position at time of market correction

When markets correct, most individual shares will also correct/ go down. Various studies show that 3 out of 4 stocks move in the same direction as the index.

Markets hate uncertainty. Uncertainty often causes corrections because large parties want to secure profits and wait with new purchases until the uncertainty has abated. When the uncertainty increases with, as now, the tensions in Ukraine, high inflation rates, extremely high (Government) debts and a possible interest rate increase of 1 to 2% (in several smaller steps of 0.25 - 0.5%), this puts pressure on the prices.

Increasing or going fully into a cash position during a market correction is an excellent way to protect your profits. After all, no one knows how far the markets may correct. Increasing the cash position should be systematic. The positions should be stopped out as soon as the stoplosses are hit by deteriorating conditions.

50 - 80 line

The market leaders are the big winners from the previous period. Research shows that when market leaders finally top, an average drop of 70 - 75% follows. For these kinds of winners, the 50 - 80 rule applies. This means that the probability of this type of share falling by 50% is about 80% and that 80% of this type of share falls by 50% on average. Just look at the former market leaders such as Zoom (ZM), Roku Inc (ROKU), DocuSign (DOCU) or Snap Inc (SNAP), to name a few examples. This does not have to mean that such shares will not become market leaders again in a subsequent upward period. After all, the 50-80 rule also applies to shares such as Apple, Amazon and Microsoft. In the past, these shares too have fallen 50-80% several times, but they have also recovered from this and have once again become market leaders.

When a correction occurs, volatility increases sharply. It is important to recognise this so that you can react adequately to the new market conditions. This can be done in several ways:

Thus, the total exposure to the market can be reduced

Reduce the number of positions

Be more selective with new positions

Take new positions with less cash (trade smaller)

Tighter stoplosses.

In a corrective market, the focus should be on protecting capital. Do not forget what a drop of 90% means! That is a stock that first fell 80% and thus appears very 'cheap'. And then it falls another 50%. However far a stock has fallen, from the moment of purchase it can always fall again by 100%.

When will ESST go into cash?

The Exclusive Signals Stock Trading (ESST) system looks for the strongest stocks in the strongest sectors to include them in the portfolio. Often the selection of stocks consists of two or three different sectors. This sector spread is designed to reduce risk, among other things.  

In addition to sector diversification, ESST continuously measures three different market indicators to further control risk. When two of the three indicators are in the red, half a position is taken. When all three indicators give a sell signal, no position is taken and ESST is 100% in cash. Many tests have shown that when these situations occur, over a longer period a negative result will be achieved. Moreover, it has a positive effect on the equity curve, which will consequently show less deep drawdowns.

No whole positions have been taken since Friday 7 January this year. However, a few half positions have been taken since then. Since 11 February, ESST has a 100% cash position. ESST is very flexible; when the market indicators turn, new positions are immediately taken.

As a private individual you have a big advantage over large market players. There are many large market players who are obliged - in good times as well as in bad times - to invest 100% of the money under management in shares. Moreover, as a private individual, you can enter and exit the market much more easily. Large market parties sometimes have several to tens of millions of shares of one fund in their possession. It is impossible for them to sell all at once without adversely affecting the price. Remember, you do not have to trade. The purpose of trading is to make money, not to 'trade'. During a market correction, it is important to trade less, apply tighter risk management and have stricter selection criteria.

If three quarters of the shares move in the same direction as the index, it makes more sense to wait for a new rising market. A larger cash position in times of market correction not only helps to preserve your financial capital but also your mental capital. After all, losing money can be very frustrating and exhausting. Stress can mean that you are not mentally ready to take full advantage of new opportunities when the upward trend starts again. And a new upward trend is definitely coming!