What is a close position?
Briefly, a close position in trading occurs when a trader cancels or terminates an existing open position in a financial market by taking the opposite position. When a trading position is closed, it is no longer active. Closing a position is also referred to as ‘position squaring.’
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A closer look at close positions
Transactions executed by traders and investors in financial markets require the opening and closing of trading positions. The initial or first position that a trader or investor takes on a transaction is an open position, which could be either a long position or a short position on the financial asset. A trader/investor takes a long position on an asset when he or she buys it with the expectation that its value will increase in the future. Conversely, a short position is a strategy used by traders when they anticipate that the value of an asset will decline in the short term, probably during the next few days, weeks, or months. Typically, a short position refers to the sale of a financial asset that a trader does not own. In order to exit an open position (long or short), it must eventually be closed. Closing a position necessitates the inverse action that initialised the position in the first place. In other words, investors/traders with long positions will sell to close, while those with short positions will buy to close their initial positions. For example, a trader holding an open position on 1 000 Naspers shares will close his/her position by selling the 1 000 shares. Contrarily, a trader with a short position on 1,000 Naspers shares will close his/her position by purchasing an equal amount of offsetting shares. Bear in mind, that closing a position offsets the open position, eliminating the original exposure. In addition to manually closing a position, open positions can also be closed via a stop-loss order or a take-profit order. A stop-loss order, typically placed with a broker, is used to buy or sell a specific financial asset once it reaches a specific price. A take-profit order refers to a type of limit order that explicitly states the exact price at which to close an open position to generate a profit. These types of orders are placed in advance and automatically reverse a trader’s position if the value of a financial instrument declines or rises to a pre-determined amount. The difference between the price of a financial asset (security) at its open position and when it is closed indicates the gross profit gained or gross loss incurred on that security position. The period between the opening and closing of a position in a financial asset (security) is referred to as the holding period for the security. The holding period may vary considerably, based on the type of financial asset and the type of trader. For instance, long-term investors may close a position in shares of companies - that are reputable and financially stable - many years after the position was first opened. By contrast, day traders typically close trading positions on the same trading day that they were opened, or a few days later.
Reasons why positions are closed
Understanding when to close a transaction is a key feature of a successful trader or investor. Closing out positions in order to secure profits and minimise losses is crucial to being a successful trader or investor. Any profit or loss is determined at the moment the position is closed and a position that has been closed, cannot be reopened. Hence, any chance to recover a loss is eliminated. There is no absolute answer to when a trader or investor should close a position because it depends on various factors and/or a variety of circumstances. Although, the trading strategy of an investor or trader could play a major role in making trading decisions. A clear trading strategy allows a trader/investor to close positions at the optimal level. For example, before entering a position, decide when you will close it at a profit and when you will end at a loss - and stand by your strategy and decisions. Put differently, timing when to close out a trade is a crucial factor in successful trading. There are various reasons for the closing of a trading position. For example:- To take profits after profit targets have been reached.
- To restrain losses.
- Reducing risk exposure.
- To generate cash.
- To take offsetting positions in swaps to eliminate the risk before maturity.
- A stop-loss order or a take-profit order has been reached.
- Margin calls
- Callable bonds
Closing a position in forex trading
Bear in mind, that closing a position in forex trading is always planned in advance. Forex trading comprises high risk, compelling a trader when closing a position to consider several key points such as risks associated with the forex market. A forex trader is allowed to close a position at the close of a trading day or anytime while the market is open. It is important to be aware that even after the closing of a position, risk prevails because the trader could still be exposed to adverse market movements such as inflation and speculation. Closing a position can mitigate the risk associated with a long position or escalate exposure for traders who have short positions. Learning and understanding how to close off positions correctly and timely can enable traders to understand how to efficiently manage their high risks and exposure in the forex market. In order to close a position in forex trading, it is important that forex traders are aware of current market movements, recognising when it is time to close out a position, generating profits or limiting losses. In addition, when closing a position, most forex traders and investors take high risk into account. It is crucial for traders/investors to consider and evaluate the past performance of the position as well as appraise their current financial position and total investment portfolio regarding the closing of a position. Generally speaking, a trader/investor should close an open position in two cases, namely:- If the value of a financial asset has reached the target profit determined by the trader in advance.
- If the price reaches the level where the trader recognises that the forecast has been incorrect and the value of the financial asset is going in the wrong way.
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