Understanding Open Positions in Trading: Definitions, Risks, and Strategies

What Is an Open Position?

An open position is any trade that remains active until an opposing transaction closes it, whether it begins as a long or short position. While open, the position is exposed to market risk from price movements. Investors manage this exposure through methods such as diversification or stop-loss orders, which makes understanding open positions important for both day traders and long-term investors.

Understanding Open Positions in Trading

For example, an investor who owns 500 shares of a certain stock is said to have an open position in that stock. When the investor sells those 500 shares, the position closes. Buy-and-hold investors typically have one or more open positions at any given time. Short-term traders may execute "round-trip" trades; a position opens and closes within a relatively short period. Day traders and scalpers may even open and close a position within a few seconds, trying to catch minimal but multiple price movements throughout the day.

Risks Associated With Open Positions

An open position represents market exposure for the investor. The risk exists until the position closes. Open positions can be held from minutes to years depending on the style and objective of the investor or trader.

Of course, portfolios are composed of many open positions. The amount of risk entailed with an open position depends on the size of the position relative to the account size and the holding period. Generally speaking, long holding periods are riskier because there is more exposure to unexpected market events.

The only way to eliminate exposure is to close out the open positions. Notably, closing a short position requires buying back the shares while closing long positions entails selling the long position.

Diversifying Open Positions to Minimize Risk

The recommendation for investors is to limit risk by only holding open positions that equate to 2% or less of their total portfolio value. By spreading out the open positions throughout various market sectors and asset classes, an investor can also reduce risk through diversification. For instance, a 2% position in various sectors like finance, tech, and health care, along with bonds, shows diversification.

Investors adjust the allocation per sector according to market conditions, but keeping the positions to just 2% per stock can even out the risk. Using stop-losses to close out positions is also recommended to curtail losses and eliminate exposure of underperforming companies. Investors are always susceptible to systemic risk when holding open positions overnight.

Managing Open Positions in Day Trading

Day traders buy and sell securities within one trading day. The practice is common in the forex and stock markets. However, day trading is risky and not for the novice trader. A day trader attempts to close all their open positions before the end of the day. If they don't, they hold on to their risky position overnight or longer during which time the market could turn against them.

Day traders are typically disciplined experts; they have a plan and stick to it. Moreover, day traders often have plenty of money to gamble on day trading. The smaller the price movements, the more money is required to capitalize on those movements.

The Bottom Line

An open position is a trade that remains active until an opposing transaction closes it, which leaves the investor exposed to market risk. Keeping open positions near 2% of a portfolio and using stop-loss orders can help limit losses and support diversification. Day traders rely on frequent position management, while long-term investors usually hold fewer positions, with higher risk for those lacking experience.