Unraveling the Concept of Closing a Position
Closing a position refers to executing a security transaction that is the exact opposite of an open position, thereby nullifying it and eliminating the initial exposure. Closing a long position in a security involves selling it, while closing a short position entails buying it back. Taking offsetting positions in swaps is also common to eliminate exposure prior to maturity.
Closing a position is also known as “position squaring.”
Key Takeaways
- Closing a position refers to canceling out an existing position in the market by taking the opposite position.
- For short sales, this means buying back the security, while closing a long position involves selling the security.
- Closing transactions are generally initiated by traders but may be force-closed by brokerage firms under certain conditions.
A Deeper Dive into Closing Positions
When traders and investors transact, they open and close positions. The initial position taken on a security is known as an open position and can be either long (buying) or short (selling). To exit this position, it must be closed. This means: If you went long, you sell to close; if you went short, you buy to close.
For instance, if an investor purchased Microsoft (MSFT) shares, those shares are held in their account. Selling those shares closes the long position on MSFT.
The difference between the purchase price (opening position) and the sale price (closing position) represents the gross profit or loss. Positions might be closed to realize profits, minimize losses, generate cash, or manage risk. Investors also close losing positions to offset their capital gains tax liability.
The duration between the opening and closing of a position is known as the holding period, which may vary greatly. Day traders typically close positions within the same day they’re opened, while long-term investors might hold onto an investment for years.
For securities with finite expiry dates, like bonds and options, the positions are automatically closed upon maturity or expiry.
Special Considerations for Closing Positions
Though typically investor-initiated, closing positions can sometimes be involuntary. For example, a margin account may have positions closed by a brokerage firm if the stock price drops significantly and the investor can’t meet margin requirements. Similarly, a short position can be subject to a buy-in during a short squeeze.
Closing positions can be partial or full. Liquidity issues may prevent an investor from closing all positions at the target limit price simultaneously. Investors may also opt to close a portion of their positions intentionally. For example, a crypto trader with an open position on three units of Bitcoin (XBT) might sell one, leaving two open positions.
Example: Understanding a Closed Position
Imagine an investor takes a long position in stock ABC, expecting its price to increase by 1.5 times the initial investment. When the stock reaches the desired price, the investor will sell the stock to close the position.
Related Terms: open position, long position, short position, hold period, margin account.
