Depending on your understanding and experiences in the stock market, closing a position can mean very different things. If you are a buy-and-hold investor, closing a position may mean taking profits on a stock you have held for a long time. If you are a day trader, you may be using stop and limit orders to close positions when certain conditions get met. We will go over everything you need to know about closing a position so you can go in and out of stock positions without making any mistakes.
- When you close a position in the stock market, you are canceling an existing position. If you are a long-term investor, that typically means selling your securities. If you are a short seller, that means purchasing them back.
- Usually, investors and traders will close a position to either lock in profits or cut their losses. However, occasionally, their broker may force them to close their positions.
What is a Position?
When an individual, such as a trader or investor, or an entity, such as a hedge fund or institution, purchases any amount of an asset in the stock market, they are opening a position. If they place a buy order, that is typically a bullish signal. If they short the asset, that is a bearish signal.
Individuals or entities can take open positions that are long, short, or neutral based on their market outlook. If they are correct about their trade, they can close their position for a profit. If they are wrong, they may lose money. Additionally, your positions can get closed either voluntarily or involuntarily. For example, if you are overleveraged on margin, you risk getting margin called and your positions liquidated.
What is a Close Position?
An open position in the stock market refers to any trade that is not closed, such as a long or short position. A position will remain open until an opposing trade, or a close position, takes place. In the context of a long position, closing a position refers to selling the security. Closing a short position involves purchasing the security back. Think of closing a position as going full circle. You are nullifying, or eliminating, your initial exposure to an open position by closing it.
Buy Then Sell
For most investors, myself included, investing in the stock market involves purchasing shares of stock. If you do not want to own shares of certain companies anymore or need to rebalance your portfolio, you will sell some of your investments. For instance, if you have a long position on a stock that tanked 50% or more recently, you may want to place a sell order to close your position and cut your losses.
Trading Both Sides
If you want to move beyond just buying and holding shares, you can play both sides. That way, no matter which direction the market moves, you can still profit. A couple of ways to do this are through options or having both long and short positions.
With options, you can buy and sell calls and puts to hedge your positions. For example, if you are expecting a strong movement in the price of Tesla stock, buy a call spread or put spread. If you buy at-the-money or out-of-the-money spreads, you will have a very favorable risk to reward ratio, which is what you want if you have a strong price prediction.
If you short a stock, your opening order will be a sell order since you are borrowing shares from your broker and selling them to make a profit when the stock falls. That means your closing order will be a buy order because you need to repurchase the shares to give them back to your broker and profit from the difference.
Stop and Limit Orders
Stop and limit orders allow you to set up closing orders that get triggered when the price reaches your pre-determined targets. For instance, let’s say you own 20 shares of Apple stock and want to sell either if the price falls below a specific price or to lock in profits if it rises to your price target. A stop order will close your position if the shares fall to the stop loss price you set. A limit order will get triggered if the price hits your target.
Market on Close
A market-on-close (MOC) order is a specific type of order that gets entered during market trading hours and executed at the last minute while the stock market is open or slightly after trading hours. This type of order can be used to open or close a position. The goal is to get in or out of the market at the most recent trading price without needing to place a market order last minute.
Example a of Closed Position
Let’s say you took a long position on Tesla stock in January 2020 when it was $100 per share. You expected the price to increase 5x from your initial purchase price. When the stock price reached your desired level in December 2020, you would have closed your position by selling all your shares.
Understanding Close Positions
When traders and investors buy and sell stocks, they are opening and closing their positions. When they make their initial trade on a security, they are opening a position. To exit the position, they need to close it.
When you close a position, you typically either lock in profits or take a loss. The difference between the opening and closing price of your position is the gross profit or loss (P&L). There are many reasons why you may close a position. For example, you may want to reduce your exposure, get cash immediately, or cut your losses.
Occasionally, your broker or clearing firm may involuntarily close your positions in a process called forced liquidation. For example, if you have a short position, but a short squeeze happens, you may end up getting margin called. That means your positions get liquidated if you do not have enough funds to cover.
The holding period is the time between how long you open and close a position. Depending on your investment or trading style, the holding period varies. For example, day traders often close out all their positions on the same day they open them. On the other hand, long-term investors may hold their positions for years or decades before closing their long positions.
Depending on your exit strategy and financial goals, there are various ways for you to close a position.
If you want to close your positions when the prices of your securities are rising, you can place a limit order that gets automatically triggered when the price reaches your pre-determined target. Another option is to place a market order in real-time as you see the price approaching your target level.
You can protect yourself from excessive losses by setting stop losses for when the price falls a certain percentage below your initial purchase price. Another way to exit your position is to actively monitor the prices and place a market order to exit when the price approaches your stop-loss target.
Though most closing positions get undertaken at your discretion, sometimes your positions may get closed by force if you are not careful. If your broker margin calls you, you may need to close out your positions to meet the cash requirements, or they will automatically liquidate your positions to free up margin in your account.
Close positions are not all or nothing. You can choose to close only a portion of your positions rather than all of them. For example, if you made a risky bet and it pans out, you can take out your initial investment while letting the rest keep running. This tactic gets commonly used by investors who regularly rebalance their portfolios or take what I like to call “YOLO bets.”
Some of my friends who regularly invest a percentage of their portfolio in meme stocks or crypto will take out their initial investment if the securities run up while keeping the rest invested. That way, they can lock in some profits while not missing out on all the action.
The Bottom Line
Before you open or close any positions in the stock market, think about your financial goals and personal preferences. What do you hope to accomplish by investing in the stock market? What type of investor or trader do you want to be?
Figuring these things out will help guide your direction and how you will close your positions. As a long-term investor, I rarely close my positions. For the most part, the only times I would close a position is if I have a negative outlook on the stock or if I was taking a risky bet and it did not work out as planned. However, what you decide to do can be very different from my strategy. Always do what is best for you.