Square Off Process in the Commodity Market

Imagine you have entered into a trade that has moved in your favour. Although you have earned a decent profit, there’s still a key step that needs to be executed to book profits and close your trade. In trading, squaring off refers to the process of closing all open positions.

A trader squares off their position by buying or selling the same quantity of the asset allowing them to exit all open positions. Knowing the square off process in the commodity market can help traders build effective trading strategies and make their trading experience more efficient. Read on to learn more about the squaring off process in the commodity market.

Square Off in the Commodity Market

The commodity market is a crucial global market that facilitates the trading of numerous goods. Through the commodity market, traders can trade agricultural products, metals, and even commodities like crude oil and natural gas.

The commodity market is not only useful for buying and selling commodities but also allows investors and businesses to hedge their positions. Moreover, traders can speculate on the price movements of commodities as well.

The commodity market offers several ways through which one can buy or sell commodities. Derivative instruments like futures contracts and options are popular ways through which one can trade commodities.

A futures contract is a derivative contract to purchase or sell a particular asset at a predetermined price on a specific date. Commodity futures have several benefits as they streamline the trading of commodities. These instruments also allow traders to manage risk, plan their trades, and hedge their positions.

Now that we’ve understood what the commodity market is and how futures are used, we can better understand the square off process and its role in the commodity market.

Let’s say you have entered a trade by purchasing a futures contract of a commodity. You might want to exit your position if you meet your profit target or if your stop levels are hit. You can square off your position by selling the same quantity as the futures contract. Similarly, if you have sold a futures contract, you can buy the same quantity to square off the position.

Importance of Squaring Off

Let’s take a look at the key reasons that highlight the importance of squaring off in the commodity market.

Exiting Open Positions

The square off process is vital while trading commodities since it allows traders to exit open positions. Through squaring off open positions, a trader can either book profits or minimise the losses of a trade.

Risk Management

Squaring off is significantly useful while managing risk. A trader can limit their exposure to the market by squaring off open positions. Additionally, it allows traders to better plan and execute their trades.

Avoiding Physical Delivery

Since commodities are physical goods, a trader might have to take or provide physical delivery after the expiry of a futures contract. Squaring off open positions can help traders avoid the obligations of physical delivery.

Types of Square Off

Let’s take a look at the different types of square-offs in the commodity market.

Offset Square Off

The offset square off process is the most common method of squaring off trades. In this method, a trader will place an opposite order with the same quantity to cancel out the current open position. If a trader has bought a commodity, a sell order of the same quantity will offset the trade and square off the position.

Opposite Trade

An opposite trade is a strategic square off option. Although it is similar to an offset square off, it allows traders to take a trade in the opposite direction and potentially generate returns. For example, if a trader has a long position, he might sell a larger quantity while squaring off the position to enter into a short position.

Intraday Square Off

Several traders enter and exit trades within one trading session. The process of closing open positions before the market session closes for the day is known as intraday square off. This protects the trader from any overnight risks.

Automatic Square Off

Automatic square off is a process of squaring off positions which is often executed by exchanges. An exchange might automatically square off your position before expiry, at specific times, or if the price moves considerably against your position.

Tips to Effectively Square Off Your Position

It is important to know how to incorporate the squaring off process into your trading strategy.

• It is important to know your take profit and stop loss levels while trading. Placing take profit and stop loss orders can help you effectively square off your positions, book profits, and minimise losses.
• If you’re following a trend, keeping alerts for key levels or having trailing stop-loss orders can help you easily exit your positions.
• Be aware of any specific time or dates when an exchange or a broker will square off your positions automatically.
• Avoid squaring off your positions at the last minute, as you may face liquidity issues leading to the trade getting executed at an unfavourable price.

Example: Squaring Off a Commodity Trade

A trader has bought futures contracts of gold at ₹75,000. The trader expects the price of gold to rise during the day itself. Hence, he places a take-profit order at ₹75,750. To minimise losses, he places a stop loss order at ₹74,500. If the price of gold hits ₹75,750, the take profit order will be executed by placing a sell order of the same quantity.

Similarly, if the price falls to ₹74,500 the trade will be closed by placing a sell order for an equal quantity. If the price of gold does not move, the trader can keep the position open and carry it forward. However, in some cases, the broker or exchange might automatically square off the position.

Conclusion

Along with entering a trade, exiting a trade is equally important. Squaring off is crucial when it comes to managing risk, book profits, and plan trades. Incorporating a disciplined square off approach can help you lock in profits and limit losses at the same time.