Square Off Trading

The term “square off” means to challenge someone to a fist fight but it has a whole another meaning in the context of trading. Jokes aside, if we were to speak about square off in the context of trading. When a trader squares off their position, it means they have closed all their trades by the end of the day, leaving no open positions. This action eliminates any exposure to market fluctuations overnight, ensuring that the trader starts the next day with a clean slate.

This is done by either selling all the positions or by offsetting the position by buying or selling the same quantity.

Let’s take an example to understand this better.

Suppose Mr. H purchases 100 shares of ABC Ltd. at ₹50 per share.

So- 100 Shares x ₹50 = ₹5000

Mr. H then monitors the movement in the share price and luckily, that day, the share price rises to ₹60. So at the end of the day, Mr. H squares off his position by selling all 100 shares at ₹60 per share.

So- 100 shares x ₹60 = ₹6000

This results in a profit of ₹10 per share, so for 100 shares, thus, Mr.H made a profit of ₹1000.

In this example, when Mr. H decided to realise his profit for the day and closed his position by selling the exact same amount of shares he purchased, we can tell that Mr. H squared off his position.

Squaring off is a common practice in intraday trading. It locks any profits or losses, leaving the trader with no further obligations or exposure to that security.

However, it's important to note that additional fees and commissions will apply if a trade remains open for more than one day.

But what’s the point of squaring off?

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Traders square off for the following reasons

• Risk aversion- When investors square off, they sell off all their investments for the day. This helps them avoid any negative impact on the share prices, arising due to unexpected events or volatility in the market on the following day.
• Profit booking- If the share price rises in favour of the trader, he/she can square off and book his/her profits without being anxious about market uncertainties on the following day.
• Cost efficiency- Often times, carrying forward positions to the next day is accompanied by additional costs and fees. Therefore, by squaring off open positions, investors can avoid extra charges.

What are some downsides of Squaring off?

• Transaction cost- There is a fee levied on each trade made during the squaring-off process. Traders might accumulate significant transaction costs trying to close all their open positions, thus, affecting their profitability.
• Tax implications- Squaring off trades can lead to significant tax liabilities. For intraday trading, gains are classified as speculative income and taxed according to the individual's income tax slab rates, which can be higher. For delivery-based trading, frequent transactions can result in higher short-term capital gains, taxed at 15%. Both scenarios can increase your overall tax burden.
• Missed profit opportunities- Frequent square-offs might result in investors missing out on profits in case the market and share prices move in favour of the investor. Premature closure of position may lead to limited profit potential.
• Complex and time-consuming- achieving the most optimal square-offs requires constant monitoring of share prices which might be time-consuming. This can also prove to be complex to new investors.

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Scenarios where a trader might square of positions

• At a profit- Where the trader enters a sell order for the entire quantity of positions at a price higher than the cost price, thus making net gains. This approach is generally taken if the price moves in the trader’s favor and he/she wants to close the position and reap the rewards.
• At a break-even point- Exiting at a break-even point, that is, the selling price is equal to the cost price, results in no net gain or loss. This is done when the trader does not want to risk any losses or anticipate any profits at his position.
• At a stop loss- A stop loss is a predetermined level at which a trader prefers to exit the position to limit potential losses. A trader squares off all positions as soon as the price hits the stop loss, resulting in a net loss. This is done in order to exit the position at a small loss rather than keeping the position open and accumulating bigger losses

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Ways of Squaring off positions

There are several ways a trader can square off his/her positions, the most common methods are as follows-

1) Market order

A market order is the quickest way to square off a position. By placing a market order, one can sell a security instantly, at the best price available in the market, prioritizing speed over price uncertainty. This type of squaring off is used to square off positions as quickly as possible at the current market price. It is straightforward and easy to use. The validity of market order is only till the end of the current trading session.

2) Limit order

A limit order allows a trader to square off his/her positions at a specific price, generally greater than the cost price. Using this method prioritizes price accuracy over execution speed and allows the trader to close the position at his/her desired price. Limit orders also help prevent slippage, which occurs when a market order is executed at a price different from the expected price due to rapid market movements. The trade is executed as soon as the price hits the set limit. A limit order expires at the end of the current trading session.

3) Good-Till-Triggered order (GTT)

A GTT order is a type of conditional order which remains active until all conditions are met. To simplify, a GTT order is a type of order that is automatically triggered once the open position meets the preset conditions. Once a GTT order is set, it stays valid until the conditions are met and the position is closed or until it is manually closed by the trader. This relieves the trader from constantly checking the market making GTT orders convenient and a flexible way to square off positions.

4) Stop Loss orders (SL)

Stop Loss orders are used to prevent further losses on a position due to unfavorable market movements. A stop loss is generally set at a price lower than the current market price. When the price hits the stop loss level, the order is automatically executed. This automatic execution helps limit losses by triggering the sale as soon as the price reaches the stop loss level.

5) Stop Loss-Market order (SLM)

Similar to SL order, a SLM order, when triggered converts into a market order, thus closing the position as soon as possible at the best available price in the market. This eliminates the chance of slippage. The key difference between a SL and SLM order is that, when triggered, a SL order can be converted to either a market order or a limit order whereas a SLM always converts into a market order.

6) Cover order

A cover order basically incorporates a buy order and a stop loss order in a single order. Which means that when you place a cover order, you specify both the price at which you want to enter the trade and the price at which you want to exit if the trade moves against you. The stop-loss order is automatically linked to the primary order, helping manage risk.

7) Bracket order

A bracket order is an intricate tool which combines three components- namely, main order with a stop-loss order and a profit-taking order. This essentially helps traders pre-define their maximum risk and desired profit upfront. By doing so, it helps them manage the risk while simultaneously locking in their profits, thus, serving a dual purpose.

Now that we have a basic understanding of the various methods for squaring off positions, we can explore which squaring-off method is most suitable for different types of traders.

To start off, we have

Scalper Trader

A scalper trader focuses on making frequent, small trades throughout the day, buying and selling individual stocks multiple times. Unlike conventional traders who aim for larger profits from fewer trades over a longer period, scalpers seek to make small profits from many trades within a short timeframe.

Intraday Trader

An intraday trader makes several trades in a day, not with the intention to invest but to capitalize on market price fluctuations and make quick profits. Any trade, specified as an intraday trade is automatically squared off at the end of the day.

Positional Trader

Positional traders are those who hold stocks or positions for a long period of time, aiming to capitalize on price fluctuations in the long term, typically a few weeks to a few months. They aim to reap the benefits of big price swings rather than small price movements in the market.

Swing Trader

A trading style that focuses on capitalizing on profits due to price movements in the short to medium term. This typically ranges from a few days to a few weeks. Swing traders use technical analysis to look for market opportunities.

To conclude…

Knowing when to square off is a valuable skill for traders since it helps manage risk and protect profits, making it an important skill among all skill levels of traders.

While squaring off can aid in risk management and capitalize on short-term gains, it may also lead to higher costs and missed profit opportunities if the market moves favorably after you exit. Assess your trading strategy, risk tolerance, and market volatility to determine the best time to square off your trades

And as always,

Happy trading with TradeJini!!!

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