What Does Locking in Profits Mean?
I'm here to explain locking in profits, which means realizing those unrealized gains you've built up in a security by selling off all or part of your holdings. When you hold an open position, you might see paper gains or losses, but they're not real until you close the position. For instance, if you're long on a stock, you can lock in profits by selling your shares for a gain, and then you're no longer exposed to swings in the underlying asset.
You might hear this called 'realization' or 'taking money off the table.' It's a straightforward way to secure what you've earned.
Understanding Locking in Profits
You, as a trader or investor, might lock in profits for various reasons, but reducing risk is often the main one. Long-term investors like you could do this to keep your portfolio balanced. Say you started with five funds equally split at 20% each; if one surges to 30%, that increases your risk. You can lock in profits by selling some of that outperforming fund and spreading the proceeds to the others, maintaining your ideal allocation to minimize risk and maximize returns.
Short-term traders lock in profits to generate income and cut risk. Imagine you open a long position after a strong earnings report, setting multiple price targets. Once the stock hits the first target, you sell one-third to lock in those profits, holding the rest for higher targets. This lets you take some money off the table, so if the stock drops suddenly, your risk is lower.
You can set these price targets using technical analysis like indicators or chart patterns if you're a trader, or base them on asset allocation and risk tolerance if you're a long-term investor.
Example of Locking in Profits
Suppose you buy 100 shares of Acme Co. at $12, and two days later, the price jumps to $36. All those potential profits are unrealized because you haven't closed any part of the position. If the stock falls, your gains shrink; if it rises, they grow.
You decide to lock in profits by selling 50 shares at $36, which gives you $1,800. Even if the stock plummets to $1, you've still profited overall. In essence, locking in profits lets you play with 'house money' on the remaining investment.
Important Disclaimer
Remember, this isn't tax, investment, or financial advice. The information here doesn't consider your specific objectives, risk tolerance, or circumstances, and it might not suit every investor. Investing carries risks, including the potential loss of your principal.
Key Takeaways
- Locking in profits means realizing unrealized gains by closing part or all of your holdings in a security.
- Open positions accrue paper gains or losses that only become real when you close them.
- Investors often lock in profits to reduce risk, among other reasons.
- It's commonly known as realization or taking money off the table.
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