Last Updated on May 24, 2022 by Aradhana Gotur
Knowledge of the technical aspects of investing helps you grasp the happenings of the financial markets and consequently to devise smart strategies and make smarter investments.
One common jargon you may have come across while discussing investing is an open position. Let’s take a look at what this term is and its relevance for you as an investor.
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What is an open position?
You are said to be entering the financial markets when you invest in a financial instrument or asset. Until the security is sold off, you are an investor in the market and your investment is called an open position. The term is, however, more closely related to the stock market due to the trading activity that takes place. So, when you buy shares, you ‘open’ a position in the market which remains open till you sell and exit from the market. Once you sell, the open position is considered ‘closed’.
A common example of an open position is when you invest in a stock. When you buy shares of a company, you open a position in that stock. Unless you sell the stock, the position remains open. Any changes in the value of the stock would affect your investment. Once you sell the stock, you close the position. Thereafter, it does not matter how the price of the stock moves.
Open position – an alternate definition
Another definition for an open position is the situation when your investment has the potential to generate a profit or a loss. When a position is open, any fluctuation in the value of the instrument would affect your investment and yield a profit or incur a loss. On the contrary, when the position is closed, any profit or loss on the investment is already realised and the investment is closed.
An open position can be established either when you invest in an instrument or after a long or short position is set up in stock.
When a position is open, the value of the instrument fluctuates, affecting your investment and resulting in profit or loss. Click To TweetHow does an open position close?
Usually, an open position closes when a reverse action on the investment is taken. For example, when you buy stock, the open position in the stock would close when you sell it. In other cases, however, the position closes automatically when the condition placed on the trade is fulfilled. A very common example is of a ‘stop loss order’ placed to sell shares. In this method of closing an open position, an investor predetermines a level, arriving at which, a sell order is immediately triggered. Therefore, when the price of the shares falls to the trigger amount the investor had set, the condition of the order is fulfilled and the stock is sold; the open position is now closed.
Risks in an open position
When the position is open, the trade is in an active condition. Any fluctuations in the market would directly impact the position. As such, open positions are risky for investors as there is a potential for loss. For long term investors, the risks are lower since they have time on their side. They can wait out market volatility and then close their positions for maximum profits. For short term investors, however, the risks are higher. They need to have a hands-on approach to their investments to open and close their positions at the right time, for maximum gains.
How to reduce risk in an open position?
Diversification is the key to reducing the inherent risks of an open position. By diversifying across instruments and sectors, investors can reduce the risks of their open positions without compromising on returns. For example, in the case of stock trading, investing in the stocks of companies across different industries would reduce the risk of opening a position through stock trading. Similarly, investors can diversify their portfolios by opening positions in stocks, mutual funds, commodities, currency, and the like. The more diversified your portfolio, the better would be the chances of reducing the risks of an open position.
You can reduce the risk of an open position is by diversifying across instruments and sectors without compromising on returns. Click To TweetPros and cons of an open position
The pros and cons of an open position lie in the risks and the management of it. With an open position, there exists a possibility of earning profits on your invested capital. This is an advantage as it allows you to grow your investments and aim for wealth maximization.
The drawback, on the other hand, is the possibility of loss. If the market does not perform as expected, your investments would incur losses and you might end up facing capital erosion. Hedging and diversification, therefore, help in reducing the risks of losses from open positions and are important if you are trading in market-linked avenues.
If you invest in the market, chances are that you have multiple open positions in varying instruments. The key is to manage your positions well. Know the risks of your investments and try to reduce them without affecting the profit potential. If you have a long-term horizon, you can reduce the risks of an open position with the buy and hold strategy. Whatever you do, know what an open position means and the risks involved in the same so that you may make the right investment decisions.
