What is an Open Position?
An open position in trading is any established or initiated trade that is yet to be closed with an opposing transaction. This position can exist after a buy (long position), a sell (short position), or through holding any financial instrument. Until an opposing trade is executed, the position remains open.
Key Takeaways
- Open Position Definition: An open position is a trade that has been established but has not yet closed out with an opposing trade.
- Example: If an investor owns 300 shares of a stock, they have an open position in that stock until it is sold.
- Market Exposure: An open position represents market exposure for the investor, and the risk remains until the position is closed.
- Day Traders: Day traders open and close their positions in a matter of seconds and aim to have no open positions at the end of the day.
Open Position Explained
For instance, consider an investor who owns 500 shares of a particular stock. This ownership constitutes an open position in that stock. When the investor sells those 500 shares, the position then closes. While long-term buy-and-hold investors typically maintain one or more open positions at any given time, short-term traders might execute “round-trip” trades where a position opens and closes within a short span. Day traders and scalpers might even open and close positions within mere seconds to capitalize on minor, multiple price movements throughout the day.
Open Positions and Risk
An open position suggests market exposure for the investor, and this risk persists until the position closes. Open positions can be held from minutes to years depending on the trader’s style and objectives.
Portfolios often consist of numerous open positions. The risk level associated with an open position relies on the size of the position relative to the account’s total value and the holding period. Typically, longer holding periods entail higher risks due to exposure to unexpected market events.
To eliminate exposure, one must close out the open positions. Interestingly, closing a short position entails buying back shares, while closing a long position involves selling the shares.
Open Position Diversification
Investors are advised to limit risk by holding open positions that equal 2% or less of their total portfolio value. By distributing open positions across various market sectors and asset classes, the risk can be minimized through diversification. For instance, an investor could hold 2% of their portfolio in stocks from multiple sectors—such as financials, technology, health care, utilities, and consumer staples—alongside fixed-income assets like government bonds. This approach ensures a diversified portfolio.
Investors may adjust sector allocations according to market conditions, but maintaining positions at just 2% per stock can help balance the risk. Utilizing stop-loss orders to exit positions is also recommended to reduce losses and eliminate exposure to underperforming companies. Investors are always vulnerable to systemic risk when holding open positions overnight.
Open Position and Day Trading
Day traders engage in the practice of buying and selling securities within the same trading day, a method prevalent in forex and stock markets. However, day trading is inherently risky and not suitable for novice traders. A day trader aims to close all open positions before the end of the trading day to avoid holding risky positions overnight or longer, during which adverse market movements could occur.
Day traders are often disciplined and experienced; they follow a predefined plan and adhere to it strictly. Furthermore, significant capital is typically required for day trading to capitalize on minor price movements effectively.
Related Terms: Long Position”, “Short Position”, “Round-Trip Trades”, “Scalpers”, “Stop-Loss Orders.
