Closing a position depends on the investor and the security type
What is closing a position?
The term “closing a position” is also referred to as “position squaring.” It is the exact opposite of an open position and relates to the security transaction’s execution. Hence, it is null, and the initial exposure gets eliminated. When people say closing a position, they might mean different things depending on the position involved. For instance, closing a long position is entirely different from closing a short position. Closing a long position means selling, while closing a short position means repurchasing a security. In swaps, taking an offsetting position is not uncommon. It is done to remove exposure before maturity.
Let us start from the beginning.
In order to fully understand what closing a position means, let us start in the very beginning. Trading transactions in the market involve opening and closing positions. Before anything else, the trader will begin with a security in an open position. And this position can have an asset that is either long or short. So, if the trader wants to get out of that position, he needs the open to be closed. And as we have mentioned, a long position is selling to close, and a short position is buying to close.
Let us start with the gross profit or loss. This is the amount difference between the price the position was opened and closed. And since we are talking about closing a position, the reason behind this might vary from one trader to another. Some want to take their profits or stem their losses, while some want to eliminate exposure or generate money. People also close their positions on a declining security to offset their capital gains tax liability. They do this so that they can realize or harvest their losses.
Next, we have the security’s holding period. We put this under the in-betweens because it refers to the time frame between the position’s opening and closing. One holding period may be different from another because investors have different preferences, and securities have different types. For instance, a long-term investor may close a long position after many years. Also, a day trader may close their positions on the same day it opened.
Some more things that you need to know
Most securities close upon the discretion of the investor or traders. However, some securities and investments do not need an initiation for them to close. For instance, bonds and options do not need the investors to close these positions. They have the maturity and expiry dates. It will automatically happen. And then, some positions get closed involuntarily or by force. This can occur in some instances, like a long position in a particular security held in a margin account. The brokerage firm can close the position by force if the stock dramatically declines and the investor fails to deposit more or the required margin. This can also happen in a short squeeze event. A buy-in can occur in a short position.