Buy to close completes a short sale trade. When investors enter a short position, they borrow shares from a third party like their broker and sell them at a high price. To close the position, they buy shares back in order to return them to the third party. The goal is to take advantage of a drop in price to pay less than the earlier sale price, pocketing the difference in the transaction.
Short selling can be challenging, especially in a turbulent market. Investors make a bet that the market value for a given stock, commodity, or other investment instrument will fall. If it does not, they may end up taking a loss on the transaction. This could be sizable if they entered a short position with a large number of stocks. Tools like analysis can help investors identify good candidates for such trades.
The buy to close is necessary in order to pull together the needed shares to repay the third party. Terms of the loan can vary depending on the agreement between trader and third party. It may be necessary to return the borrowed shares within a set period of time, for example. Traders have some flexibility in deciding when to buy to close because they need to be able to take advantage of the best possible purchase price.
Precise timing is an art form. Traders who buy too early may watch the price continue to fall after they buy to close. People who wait to long can see prices start to trend back up. It may still be possible to salvage the trade by acting quickly to buy before the price exceeds that paid by the earlier buyer. Investors may monitor the news as well as the financial market to look for events that might impact securities pricing.
Losses can occur when the price has risen by the time the trader must buy to close. In this case, traders must front the additional money from their own pockets in order to secure enough shares to repay the third party in the transaction. A brokerage may become concerned if the trader’s assets are less than liabilities, including loans of securities. It can issue what is known as a margin call, asking the trader to correct the imbalance by selling or transferring securities. This can also be done automatically by a brokerage which may exit an unfavorable position on behalf of a trader to prevent losses.
