What is Closing a Position in Trading?
When it comes to closing a position, we are talking about ending an already open trade, whether to take profits or cut losses. This can be done manually if the trader closely monitors their trades, or automatically through stop-loss orders, which help limit risks for both long and short trades.
The reasons for closing a trading position are varied. It could be to take profits from an open long or short position, or to minimize risk when the market appears to be moving in the opposite direction. Sometimes, closing a position is also to avoid forced liquidation by the market or your broker, or to increase liquidity in your account for a larger position.
Talking about short selling, this is the act of opening a position based on the expectation that the price of a financial instrument will decrease, and then closing the position to capture potential profits. To short sell, you first have to “borrow” shares virtually from your broker to open the position. When it’s time to close this position, you “return” these borrowed shares to the broker, and any profits or losses are accordingly calculated.
Exiting a long position is the most common activity, where you open a buy trade expecting the price will rise, and then close the position to profit from the price difference. To close such a position, the trader “exits” the market by reversing their trade, effectively selling the asset back to the broker at the current market price and capturing potential profits.
However, in some cases, traders are not required to close their position. This can happen if the instrument they are using has an expiration date, such as with derivatives like futures or options contracts. In these cases, the position is automatically closed when it reaches its predetermined expiration date, regardless of whether the trader wants to close it or not.
Notably, in some situations, positions are not voluntarily closed but are forced by the broker or the market. This can happen due to improper risk management or extremely volatile market conditions. The most common type of forced closure is a margin call, which is a demand by the broker for you to invest more cash or close the position. Failing to deposit more cash in your account when margin-called can lead to forced liquidation in your account, forcing you to close positions at a loss.
Example of Closing a Position
Let’s consider a specific example of closing a position in trading, which clarifies this process and how it can yield profits for the trader. Suppose a trader decides to open a long-term buy position on Microsoft (MSFT) stock, currently priced at 250 USD per share. After two days, the stock price rises to 255 USD, and the trader decides it’s time to take profits, thus choosing to close their position. This action would result in a profit of 5 USD per share invested.
The process goes as follows: The trader spots an opportunity to profit from the MSFT stock price, predicting that the share price will increase after a certain event (such as Microsoft launching a new product). Then, the trader opens a long-term buy position with their broker (where you buy low and sell high) and waits for the price increase. Once the share price meets the trader’s expectations (for example, 255 USD), they close the position and take the potential profits.
This example highlights the importance of closely monitoring the market and making accurate decisions on when to close positions. Closing positions at the right time not only helps traders maximize profits but also minimizes risks, especially in a volatile market.
Conclusion
Closing positions in trading is not just about hitting the “sell” button on your broker’s interface; it’s a carefully considered decision, based on a deep understanding of the market, risk strategy, and personal goals. Each closure of a position not only marks the end of a trade but also provides valuable lessons for future decisions.
In the volatile world of trading, learning how to correctly close positions can be key not just to protecting profits but also to effectively reducing risks. I hope this article has provided you with a comprehensive view of the importance of closing positions in trading, and that you will apply this knowledge to your trading strategy for long-term success.
