What Is a Close 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 would entail selling it, while closing a short position in a security would involve buying it back. Taking offsetting positions in swaps is also very 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.
- In a short sale, this would mean buying back the security, while a long position entails selling the security.
- A closing transaction is generally initiated by a trader but, in some instances, it may also be forced closed by brokerage firms if certain conditions are met.
Understanding Close Positions
When trades and investors transact in the market, they are opening and closing positions. The initial position that an investor takes on a security is an open position, and this could be either taking a long position or short position on the asset. In order to get out of the position, it needs to be closed. A long will sell to close; a short will buy to close.
Closing a position thus involves the opposite action that opened the position in the first place. An investor who purchased Microsoft (MSFT) shares, for example, holds those securities in his account. When he sells the shares, he closes the long position on MSFT.
The difference between the price at which the position in a security was openedand the price at which it was closed represents the gross profit or loss on that security position. Positions can be closed for any number of reasons—to take profits or stem losses, reduce exposure, generate cash, etc. An investor whowants to offset his capital gains tax liability, for example, will closehis position on a losing security in order to realize or harvest a loss.
The time period between the opening and closing of a position in a security indicates the holding period for the security. This holding period may vary widely, depending on the investor's preference and the type of security. For example, day traders generally close out trading positions on the same day that they were opened, while a long-term investor may close out a long position in a blue-chip stock many years after the position was first opened.
It may not be necessary for the investor to initiate closing positions for securities that have finite maturity or expiry dates, such as bonds and options. In such cases, the closing position is automatically generated upon maturity of the bond or expiry of the option.
Special Considerations
While most closing positions are undertaken at the discretion of investors, positions are sometimes closed involuntarily or by force. For example, a long position in a stock held in a margin account may be closed out by a brokerage firm if the stock declines steeply, and the investor is unable to put in the additional margin required. Likewise, a short position may be subject to a buy-inin the event of a short squeeze.
A close position might be partial or full. If the security is illiquid, the investor may not be able to close all his positions at once at the limit price specified. Also, an investor may purposely close only a portion of his position. For example, a crypto trader that has an open position on three XBT (token for Bitcoin), may close his position on only one token. To do this, he will enter a sell order for oneXBT, leaving him with two open positions on the cryptocurrency.
Example of a Closed Position
Suppose an investor has taken a long position on stock ABC and is expecting its price to increase 1.5 times from the date of his investment. The investor will close out his investment, after the price reaches the desired level, by selling the stock.
