What is an open position?
An open position in trading and investing is a position – also referred to as a trade – that a trader or investor takes in a financial market. An open position remains open until it is closed with an opposite trade.
An open position allows a trader or investor exposure to a financial market, enabling them to generate profits from trades. However, there is also a possibility that an investor or trader can incur losses during the duration of an open position.
When an open position is closed with an opposing trade, all profits gained or losses incurred are realised, and the trade is considered inactive.
An open position can be a long position due to a buy by a trader/investor, or a short position because of a sale of a financial instrument. A long position on a financial asset is closed when a trader or investor sells the asset, while a short position is closed when a buy transaction occurs.
Sometimes, open positions would be closed automatically. For instance, a futures contract when it reaches its expiry date. Also, when an open position had a stop-order, or a limit-order attached, which was subsequently filled.
Explaining open positions
Simply put, an open position gives a trader or investor exposure to a financial market, allowing a chance of profit or loss.
Professional traders usually hold a number of open positions simultaneously, aiming to maximise their profits.
Open positions require traders/investors to be vigilant and to be constantly aware of market movements.
There are various factors which affect the dynamics of an open position of which the following two are the most important factors: the timespan (duration) of an open position, and risk exposure during open positions:
Timespan of an open position
The duration of an open position can vary considerably, depending on the type of trader and his/her trading strategy. For example:
- Position traders
Position traders are trend followers who are convinced that once a trend starts, it is expected to continue for some time.
A position trader purchases a financial asset for the long term, expecting that it will increase in value. Position traders are less worried about short-term price fluctuations in the market and daily situations that influence the market unless they change a trader’s long-term view of his/her open position.
Successful position traders determine favourable entry and exit prices in advance and manage risk via stop-loss orders.
Typically, they do not trade actively, with most of them opening less than ten trades in a year.
Position traders, as well as buy-and-hold investors (see below), are not required to constantly pay attention to their trades. Although, they will do a lot of research in advance, determining the intrinsic value of the financial asset and comparing it with the market price.
- Buy and hold investors
Buy-and-hold investors are classified as passive investors. They hold their open positions even longer than those of position traders.
- Day traders
The strategy of day traders is to take advantage of short-term price fluctuations in financial markets.
A day trader only keeps open positions for a relatively short period of time, varying from a few minutes or a few hours to a few days. However, day traders usually want to buy and sell financial assets (securities) within one trading day, aiming to close all their open positions before the close of a trading day.
Holding on to a risky open position overnight or longer, a day trader runs the risk that a market could turn against him or her.
Day trading requires not a lot of fundamental research, because day traders base their open positions on technical factors instead of the intrinsic value of a security.
Contrary to long-term open positions, short-term open positions compel traders to be very attentive to even minute details, because closing an open position at the right time can be the difference between a profit or loss. Hence, day traders are usually disciplined trading experts who have a plan, which they follow constantly.
Typically, day traders often have enough funds to gamble on day trading. The smaller the price movements, the more capital is needed to generate profits on those movements.
- Swing traders
Swing traders may hold an open position on a financial asset for a few weeks or months because they assume the asset will soon experience a rise in value.
Risk exposure during open positions
Holding an open position implies that a trader or investor is exposed to market risk. The risk remains until the open position is closed. As mentioned, open positions can be held from minutes (day traders) to years (position traders and buy-and-hold investors).
Usually, portfolios of traders or investors, contain numerous open positions. The level of risk associated with an open position is based on the size of the open position in relation to the account size and holding period, which is the time period between the opening and closing of a position in a financial asset (security). Typically, long holding periods entail more risk due to more exposure to unanticipated market events and movements.
The only method to eliminate risk is to close out the open positions.
However, while having open positions, the following actions can be considered:
- Diversify open positions across various different industries and sectors, such as transport, information technology, financials, and mining.
- Do not risk too much of your capital on open positions. For novice traders or investors, it is wise and safe to not risk more than 2 percent of their portfolio value on open positions.
- Short-term traders should also use a stop-loss strategy, ensuring they do not suffer a huge loss on a trade if a situation turns wrong.
- Novice investors, who trade with small amounts of capital, should avoid using too much leverage.
Examples of open positions
Example #1
Let us say, a trader, named Alexia, buys 1,000 Prosus shares, giving her an open position in those shares of the company. By buying the shares, Alexia has taken a long position.
Alexia expects the value of the shares to increase and chooses to wait a year, before selling the 1 000 Prosus shares. When she sells the 1,000 shares, her open position will be closed.
Example #2
The following is an example of opening a short position, meaning a trader is selling securities that are borrowed with the expectation that the value will decrease, allowing the trader to buy the securities back at a lower price and to replace the borrowed securities. Using this strategy, the trader expects to realise a profit.
Let us assume, the shares of company AAA are currently trading at R150 per share. Helgard believes that the value of the shares will decrease during the following three months. Helgard instructs his broker to short-sell 300 shares of the stock of company AAA. This means that Helgard’s trading account increases by R45 000 (300 x R150).
After three months, the value of AAA’s shares drops to R130 per share. Helgard purchases back the 300 shares, thus closing his short position which he opened three months ago. Helgard pays R39 000 (300 x R130) to repurchase the shares which he returns to his broker.
The profit generated by Helgard is R6 000 (R45 000 – R39 000).
Conversely, if the value of the shares had increased to R160 per share, Helgard would have paid R48 000 (300 x R160) to cover its short position, incurring a loss of R3 000 (R48 000 – R45 000).
Advantages of an open position
An open position enables a trader or investor to generate a profit. Without having an open position in a financial asset, a trader/investor would have no exposure in a financial market, deprived of the chance to receive any returns.
Leverage can be an important method for a trader to maximise income on open positions by gaining more market exposure using a small initial deposit. However, leverage can also escalate losses if not used wisely.
Disadvantage of an open position
An open position can also present the risk of losing money. If a financial market does not perform as expected, trades can cause losses, eroding a trader’s capital.
Hence, it is crucial for a trader or investor to apply a risk management strategy.
Note: This article does not constitute investment, financial or trading advice. Please obtain the advice of a professional, reputed, and regulated broker before making trading and investment decisions.
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