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During a stock market correction, it is natural to feel anxious and wonder if cashing in one’s portfolio is the best course of action. As a seasoned trader, I’m here to tell you that going to cash during a correction is not a rookie move – in fact, it can be a powerful strategy when uncertainty reigns.

Whether the stock market is making new all-time highs or in the midst of a stock market correction, it is never to early to develop a game plan for how you will manage the risk and lower your exposure to a major downturn.

Assessing Your Long Exposure and Position Sizing

When your portfolio is bleeding and stocks are plummeting, the urge to pull everything out and sit on a cash pile can be overwhelming. However, before making any rash decisions, it’s crucial to assess your situation objectively.

First, consider your long exposure and position sizing. If your heart is racing and you’re losing sleep over the market’s volatility, this might be a sign that you’re overexposed. So much of successful trading comes down to knowing how your emotions will react to position size on individual trades and your market exposure in general.

Your sentiment towards the market should be reflected in how long or short you are. When confidence is high, increasing your long positions makes sense. But when uncertainty prevails, like it periodically does, reducing your exposure and holding more cash can be a prudent move.

Remember – your position size should align with your risk tolerance and the market’s current conditions. What it should not align with is your hopes or how much money you want to extract from the market.

When we do that, we set ourselves up for grave disappointment and extreme drawdowns during stock market corrections, and even worse, our decision making only becomes more problematic during these times. That is why it is so critical for you to have a plan in place for position sizing, as well as capital exposure for when the inevitable market corrections do happen.

Adapting Your Swing Trading Strategy

Swing trading during a downturn requires adaptability. Holding onto stocks that have fallen significantly from their highs, hoping they’ll rebound, is not a sound strategy. Instead, have a plan in place for taking profits and cutting losses. Remember, swing trading is not designed for weathering prolonged downturns. If a trade goes against you or the market shifts unfavorably, don’t hesitate to exit and preserve your capital.

It’s essential to have a well-defined strategy that accounts for various market scenarios. This includes setting clear entry and exit points, managing risk through proper position sizing, and being prepared to adjust your approach as conditions change. By having a solid plan in place, you’ll be better equipped to navigate the challenges that come with swing trading during a correction.

Accepting Uncertainty as Part of the Game

It’s important to accept that uncertainty and difficult periods are part of the trading game. They will happen on every time frame. If the market always went up without any pullbacks, everyone would be a trader. The key is to prepare for these challenging times and adjust your approach accordingly.

Embrace the fact that there will be ups and downs, and focus on developing the mental fortitude to weather the storms, and you can do that by actively managing the risk in every one of your trades. When the market is going up day after day, that is the time that you need to be thinking about, “what if this market was to reach a stock market top tomorrow and begin a correction?”

One way to cope with uncertainty is to continually educate yourself about the market and various trading strategies. By expanding your knowledge base, you’ll gain a deeper understanding of how to navigate different market conditions. Additionally, surrounding yourself with a supportive network of fellow traders can provide valuable insights and emotional support during tough times.

The Power of Cash During a Stock Market Correction

Being in cash during a correction can give you a position of power – you can pick and choose the right moments to re-enter the market when the risk-reward ratio is in your favor. Use your time in cash to research and plan your next moves, so you’re ready to act when the opportunity presents itself.

The benefits of being in cash during a stock market correction include the following:

• Cash provides a safety net during market downturns, allowing you to preserve capital and avoid significant losses and drawdowns.
• Holding cash gives you the flexibility to seize opportunities when the market stabilizes, enabling you to invest in undervalued stocks or sectors, and add to the portfolio’s net worth rather than trying to make up for recent losses.
• Having a cash reserve allows you to maintain a level-headed approach and avoid impulsive decisions driven by fear or panic. When the market is selling off, you not are getting hit nearly as hard as you would be if you were 100% long, or even worse, trading in margin.
• Cash enables you to rebalance your portfolio during a correction, ensuring that your asset allocation aligns with your risk tolerance and investment goals.
• By keeping a portion of your portfolio in cash during a stock market correction, you can reduce your overall risk exposure and minimize the impact of market volatility on your investments.

While sitting on the sidelines might feel unproductive, it’s important to remember that preservation of capital is crucial for long-term success. By avoiding a significant drawdown in your swing trading portfolio during a correction, you’ll be better positioned to capitalize on opportunities when the market does stabilize. Use this time to reassess your strategy, identify sectors or stocks that show promise, and prepare a watchlist of potential trades.

Signs It’s Time to Start Trading Again

So, how do you know when it’s time to start trading again? Look for signs of stabilization in the bond market and a decrease in yields. Keep an eye on the major indices and sectors for indications of a potential bounce.

Additionally, pay attention to the stock market making extreme moves during major negative news events, where the market tests new lows but then intraday goes on a face-ripping rally instead. Often times those moments suggest that the stock market has finally reached a bottom.

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Another factor to consider is the overall economic landscape. Are there any upcoming events or reports that could potentially impact the market’s direction? By staying informed about key economic indicators and geopolitical developments, you’ll be better equipped to make informed decisions about when to re-enter the market.

During the Covid-19 shutdown in March of 2020, the market was in a complete free fall, but then the Federal Reserve announced that going to cut interest rates to zero and jumpstart $700 billion in quantitative easing on March 15. This was followed by a whole host of other actions that were announced through March 23. The stock market instantly bottomed and went on one of the greatest, unexpected rallies of all time.

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One more thing about finally getting back in to the stock market following a stock market correction – most traders start to speculate with garbage, low volume, or small-cap stocks. That is probably the worst move you could make, in my opinion.

Instead, you may want to focus on high quality stocks, like Apple (AAPL), Amazon (AMZN), Nvidia (NVDA), Caterpillar (CAT), or Costco (COST) – to name a few – that you know the stock market will need to have participate if the bounce is truly going to continue.

Managing Risk and Emotions

One of the biggest challenges traders face during a correction is managing their emotions. Fear and greed can lead to impulsive decisions that ultimately harm your portfolio. It’s essential to develop a disciplined approach to trading that prioritizes risk management and emotional control.

My preferred method of managing risk is to use stop-losses on all of my swing trades and avoiding overexposure to any single sector or industry. By implementing these risk management techniques, you’ll be better prepared to handle the risks that come with trading during a stock market correction.

When it comes to managing emotions, it’s important to maintain a level-headed approach and avoid letting short-term fluctuations dictate your actions. Stick to your plan, trust your analysis, and be patient. Remember, success in trading often comes from consistent, disciplined action rather than impulsive decisions driven by fear or greed.

Cash: Your Ally in Uncertain Times

In conclusion, going to cash during a stock market correction is one of the best ways to avoid large market downturns – it’s a strategic decision that can help you weather the storm and emerge stronger on the other side. By managing your exposure, having a clear plan, and accepting uncertainty as part of the process, you’ll be better equipped to navigate even the choppiest and most unstable of markets.

Remember, sometimes the best trade is no trade at all. By preserving your capital during a correction and waiting for the right opportunities to present themselves, you’ll be well-positioned for long-term success in the markets. Stay disciplined, manage your risk, and keep a level head – these are the keys to thriving as a trader, no matter what the market throws your way.

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