Master the Art of Locking in Profits: Secure Your Earnings and Minimize Risk

Learn how to effectively lock in profits to secure gains and manage investment risk, whether you're a short-term trader or long-term investor.

Locking in profits refers to the realization of previously unrealized gains accumulated in an investment by closing all or a portion of the holdings. When an investor holds an open position, they may accumulate unrealized or paper gains or losses that aren’t recognized until the position is closed. For instance, an investor with a long position on a security can lock in profits by selling their stake for a gain. This action prevents them from being impacted by future changes to the security’s value.

This process is also known as realization or taking money off the table.

Key Takeaways

  • Locking in Profits involves realizing previously unrealized gains by closing all or a portion of investment holdings.
  • Investors accrue unrealized gains or losses while holding an open position, which are only recognized once the position is closed.
  • The primary reason investors lock in profits is risk reduction.
  • Also known as realization or taking money off the table.

Understanding Locking in Profits

Investors and traders may lock in profits for various reasons, but overwhelmingly, it is to mitigate risk.

Long-Term Investors and Portfolio Balance

Long-term investors might lock in profits to maintain the desired balance of their portfolios. For example, how might someone who started with a balanced portfolio of five funds behave if one fund outperforms the others, increasing its portfolio allocation from 20% to 30%? They may choose to lock in a portion of the profits from the outperforming fund and redistributing those proceeds to other funds. Doing so helps maintain a balanced portfolio, minimizing risk and optimizing potential profits.

Short-Term Traders and Immediate Gains

Short-term traders frequently lock in profits for income generation and to lessen risks. Suppose a trader enters a long position after a positive earnings report with specific price targets in mind. Upon reaching the first price target, they might sell a third of their position, leaving the remaining two-thirds to aim for higher targets. This strategy enables them to ’take some money off the table,’ reducing potential losses if the stock price reverses direction.

Both traders and long-term investors rely on strategies to lock in profits—traders typically use price targets set through technical analysis and indicators, while investors consider risk tolerance and asset allocation when deciding to realize gains.

Example of Locking in Profits

Imagine you buy 100 shares of Acme Co. for $12 each, and the stock price rises to $36 within two days. All potential profits are unrealized because you have not sold any shares. If the stock’s price falls, your unrealized profits will decrease, and if the price rises, your potential gain increases.

To lock in profits, you decide to sell 50 shares, yielding a profit of $1,800 (50 shares x $36 per share). Even if the stock price were to drop to $1 afterward, you would’ve still realized gains, effectively playing with ‘house money’ for the remaining shares.

Investing carries risks, including possible principal loss. Any given financial strategy should fit your personal investment goals and risk tolerance.

Related Terms: unrealized gains, open position, risk tolerance, asset allocation, technical analysis.


Get ready to put your knowledge to the test with this intriguing quiz!

--- primaryColor: 'rgb(121, 82, 179)' secondaryColor: '#DDDDDD' textColor: black shuffle_questions: true --- ## What does it mean to "lock in profits"? - [x] To secure realized gains by selling an asset - [ ] To buy more assets during a bull market - [ ] To only invest in safe, low-risk securities - [ ] To minimize risks by diversifying a portfolio ## Which of the following is a common method to lock in profits? - [ ] Holding an asset indefinitely - [x] Selling an asset after it appreciates in value - [ ] Only buying in a bearish market - [ ] Ignoring market conditions ## What is a trailing stop order primarily used for? - [ ] Reducing transaction fees - [x] Locking in profits by setting a dynamic stop price that moves with the asset price - [ ] Increasing market volatility - [ ] Holding a position to maturity ## Why might an investor choose to lock in profits when they believe the market will become volatile? - [ ] To avoid paying taxes - [x] To protect against potential losses - [ ] To increase market exposure - [ ] To leverage risky investments ## Which term is most associated with locking in profits? - [ ] Dollar-cost averaging - [ ] Buy and hold - [ ] Margin trading - [x] Realized gains ## When an investor sells a position to lock in profits, what happens to the liquidity of their portfolio? - [ ] Liquidity decreases - [ ] Liquidity remains unchanged - [x] Liquidity increases - [ ] Liquidity loss occurs ## Locking in profits can help to achieve which of the following for an investment portfolio? - [ ] Unlimited risk exposure - [x] Balanced risk and return - [ ] Perpetual gains - [ ] Guaranteed returns ## Locking in profits can be particularly important in which type of market condition? - [x] Highly volatile markets - [ ] Perfectly stable markets - [ ] Slowly declining markets - [ ] Markets with no price movement ## What is the main downside of frequently locking in profits? - [ ] Increased long-term capital gains tax - [ ] Higher dividends received - [ ] Lower transaction costs - [x] Possible opportunity cost if the asset continues to rise ## Which investor behavior does locking in profits typically counteract? - [ ] Over-diversification - [ ] Stockpiling cash reserves - [ ] Avoiding investments - [x] Greed and overconfidence in continued inflation of asset prices