An investment alternative that active market players seldom talk about is cash. It can be one of your best strategic investments, not only because it allows you to enter and exit the market in a timely manner, but also because of its tremendous psychological impact.
Investment professionals often talk about 'protection' when they are fearful that the market may be due for a correction. The idea is to not sell your precious investments but to use puts or some other vehicles that allows you to capture gains in the event the market may go down. Typically, this 'protection' is characterized as costing very little but providing significant gains if it works. Like most things in the stock market, it isn't that simple or easy. Fully hedging long positions is not cheap and it is not easy to determine what positions may drop faster or deeper. Index puts have to be bought on a very large scale to protect you from downside if you are holding high beta stocks which have much higher levels of volatility than the broad indices. If your stocks are dropping 10% when the indices correct, 2% index puts or shorts aren't a big help.
The only way to be fully protected from market upsets is by holding cash. Cash is the ultimate safe harbor, but one of its greatest benefits is that it gives you an opportunity to make mental adjustments as you wrestle with the market. Rather than just hold on to positions when you feel out of tune with the market, the better move is to stand aside and give yourself time to gain mental clarity.
Anyone that is active in the market is going to have some sort of bias about market direction due to the positions that they hold. Cash can help you gain some real objective, although you may find yourself hoping for a market crash if you have plenty of idle funds. When you look at stocks with fresh eyes when you don't have positions, your view of whether they are good or bad will often be quite different than if you already own them.
I strongly believe that every trader should periodically go completely (or close) to cash (you can always rebuy stocks that you like) because it helps you to regain objectivity and balance. It forces you to question why you are holding a position. Often, we hold stocks simply out of inertia or emotional attachment. We must force ourselves to question our positions at times, and going to cash will force you to do that.
Many investors scoff at this advice, but those who hold stocks for the long-term are the most likely to act for emotional reasons. When you hold a stock for years, it is easy to lose sight of why you should continue to hold it. Being forced to sell it and buy it back makes you think about it. There may be tax issues or other costs, but the exercise can still be well worth it unless your holding period is forever like Warren Buffett. I tend to completely ignore tax issues in my trading and investments because it often leads to poor decisions when taxes are given too much weight.
If you are struggling with your investing or trading the best thing you can do is clear the decks and go completely to cash. You are freed of the baggage of the stocks that have caused you stress and anxiety and won't be driven to constantly second guess why you are holding something. With a clean slate you can then take steps to find good trades and regain your confidence.
In the past week I have raised my cash levels significantly. I'm not particularly bearish or bullish - I don't know where the market is headed - but I don't see much price action that I like and want to reset my thinking and approach a bit. If the market is headed higher from here I'm not concerned about missing out as I can quickly make buys. If the market is headed lower than I will be well positioned to make some strategic moves.
One of the great things about the stock market is that you can make a fresh start any time you want. Just hit the sell button and go to cash. It isn't complicated and it can have a profound effect on your trading. Cash is power.