What is a Close Position?
When you decide to invest in a stock or buy an option, you open a position. You’re invested, and you’ll stay invested until that position expires or you choose to sell out of it. As you might imagine, this is a close position. It represents a divestment, at which point you realize your gains or losses from the investment.
Every investment culminates in a close position, no matter how different the action of closing might look. For instance, you might sell your shares in a mutual fund to close. Meanwhile, the issuer of a callable bond might trigger the call action, paying you back your premium to close your position. The result is the same: you no longer have a vested interest in the investment vehicle.
It’s important for investors to understand the implications of a close position before they open one and throughout the life of their investment. Because the close represents the culmination of your investment thesis and strategy, it needs to adapt over the life of the position.
Realizing Gains or Losses
So long as you’re invested in an open position, any gains or losses incurred are unrealized. This is because no one can tell the future. Closing the position locks in whatever the outcome is at the moment of the close.
Say, for example, you’re down $5,000 in a position today. If you sell out and close your position, you’re accepting (realizing) that loss. However, if you keep your position open and the stock recovers, your losses may be lower in the future. Two months from now, you might only be down $2,000 in that position. A year from now, you might be up $1,000.
No gains or losses are real until you divest your position. And, when you do, it triggers a taxable event. If you made money on your investment, you’ll face capital gains. If you lost money, you’ll realize your losses and can even offset capital gains from other positions. Closing a position finalizes the investment transaction.
How to Close a Position
Taking a close position looks different depending on the nature of the investment. The close is always the opposite action of the open, which means you either need to buy or sell an investment:
- Selling to Close. This is the most common type of close position. It simply means selling a security or investment product you’ve purchased. For example, if you open a position in Walmart Inc. (NYSE: WMT) with a purchase of 50 shares, you’d need to sell all 50 shares to close your position.
- Buying to Close. This type of close position is specific to short-selling. When you short a stock, you first borrow shares and sell them, with the promise of returning the borrowed shares later. To close the position, you need to buy and return them (hopefully at a lower price).
Whether it’s stocks, bonds, derivatives or another type of investment, closing involves severing your interest in the transaction. This process is also called “squaring the position” since it effectively settles the transaction.
Forced Close Positions
There are instances where investors may find themselves forced to close a position. These situations are rare and usually avoidable.
- Failing to meet the requirements of your margin account can force a close position when your broker initiates a margin call. In this situation, the broker needs to know that you have the funds to cover any open positions. If you can’t, the broker will force a close to either mitigate the risk of loss or to ensure there’s enough funds to cover other positions.
- Callable bonds are another type of forced close, triggered by a bond issuer. Assuming the bond is out of its call protection period, the issuer can recall the bond by paying back the premium. This effectively creates a close position and, unfortunately, cancels out any remaining interest payments.
- In the world of property investment, a foreclosure is a type of forced close. Assuming the investor is unable to cover the cost of the mortgage, the bank will step in and repossess the property. By recovering the asset, the bank is able to resell it and recover some of the cost of the original mortgage. The investor no longer has any claim to it.
Any instance in which the investor doesn’t initiate the close position is a type of forced close. In some cases, it’s possible to stop the close, such as paying the mortgage or adding funds to a margin account. Other times, it’s unavoidable and simply a risk associated with that particular investment, like a callable bond.
When Should You Close a Position?
Ideally, investors should enter a close position in one of two situations: when your investment thesis has run its course or when the circumstances of the investment change for the worse.
Let’s say, in the first scenario, that you believe ABC Company will see massive growth over the next five years. You open a position and continue to add to it for five years. Then, true to form, the company begins to plateau. You adopt a close position and take your profits, locking in your gains. This is, in a nutshell, the concept of profitable investing!
Not everything goes according to plan, though. Say that you decide to short XYZ Company because you believe they’re poised for poor performance. However, after opening a short position, a turn of events stabilizes the price and jumpstarts growth. Your thesis has changed, so you close at a small loss before it has a chance to grow.
Both of these examples show the importance of considering your exit strategy before you open a position and during the length of your investment. Remember, so long as your position is open, you have a vested interest. A close position settles the transaction and your interest.