What it means
To be square means that long positions (what you own or have bought) and short positions (what you have sold or owe) cancel out. If a trader has bought 5,000,000 euros and sold 5,000,000 euros, the net position is zero.
A square position is useful because it removes the risk of price moves. A trader who is square cannot gain or lose from a change in the exchange rate on that amount, and a bank that is square has no exposure to an overnight move.
Banks and trading desks often aim to be square at the close of the day. This means they do not carry large positions through times when the market is thinly traded or when news might break, and it simplifies the risk reporting for the next day.
Companies also use the idea. A business with euro receipts of 2,000,000 and euro payments of 2,000,000 over the same period has a naturally square position in euros, so it needs no hedge for that amount, although the timing of the cash flows may still differ.
Matching receipts with payments in the same currency in this way is called a natural hedge. The phrase "squaring a position" refers to the act of closing it, by doing an equal and opposite trade.
The word "square" is also used for a dealer's book that is balanced overall, even if it contains many individual deals. A square position is not the same as a risk-free position.
Being square in one currency says nothing about other risks, such as interest rate risk or a counterparty failing to pay, and positions that look square can differ in timing, which can create exposures.
In practice
Real-world examples.
Example
A bank's currency dealer ends the day with equal purchases and sales of yen. She reports a square position to her manager, who can then go home confident the bank has no overnight exposure.
Example
An importer pays a supplier 800,000 euros and, in the same month, receives 800,000 euros from a customer. The company is square in euros, so it needs no currency hedge for that month.
Example
A commodity trader has contracts to buy 10,000 barrels of oil and contracts to sell the same amount. The trader is square in oil, and the profit now depends only on the difference between the buying and selling prices already agreed. Further price moves in the market no longer matter to the result.
Formula
Calculation
Net position = total bought - total sold
A treasury desk buys 5,000,000 euros in the morning, then sells 3,000,000 euros at midday and a further 2,000,000 euros in the afternoon. Net position = 5,000,000 - (3,000,000 + 2,000,000) = 5,000,000 - 5,000,000 = 0. The desk is square, so a change in the euro exchange rate overnight will not affect its profit.Case study
Seen in the real world.
Kingsway Exports is an illustrative, fictional company that sells goods in euros and buys materials in euros. Over a quarter it expected to receive 3,000,000 euros and pay 2,800,000 euros.
The treasurer realised the company was almost square, with a net exposure of only 200,000 euros. Instead of hedging the full 3,000,000 euros with expensive forward contracts, she hedged just the 200,000 euros, costing far less.
The illustrative lesson is that matching receipts and payments in the same currency cuts the amount that needs hedging. She also checked the timing, because if the payments fell due a month before the receipts, the company would still need short-term funding. Kingsway now tracks expected receipts and payments by currency and month in a simple schedule, which shows its net position at a glance. The treasurer reviews the schedule each week and updates it when a customer changes a delivery date.
Watch out
Common mistakes.
- Assuming a square position carries no risk at all, when other risks such as timing, interest rates or counterparty failure remain.
- Counting only the totals and ignoring timing, so that a position looks square but is open for part of the period.
- Confusing a square position with a closed account, when the deals can still be outstanding and awaiting settlement.
Questions
People also ask.
What does it mean to square a position?
It means to close it by doing an opposite trade of the same size, which brings the net exposure to zero.
Why do banks want to be square at the end of the day?
They avoid carrying risk overnight, when markets are quieter and unexpected news can cause large price moves.
Is a square position the same as a hedge?
A hedge is a trade designed to offset an existing risk, while a square position is the result when the offsetting is complete and nothing is left open.
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