What it means
A gain on paper is not yet real. If you bought shares at $40 and they now trade at $55, the $15 gain can vanish if the price drops back, so many investors choose to secure some of it.
Locking in profits is a decision about risk, not a prediction about the market. The most direct method is to sell all or part of the holding, which turns the paper gain into cash.
A common middle path is to sell part, for example half, which secures some profit and leaves the rest to run. Another is to use a trailing stop-loss order, which sells automatically if the price falls a set percentage below its highest point.
More advanced investors use derivatives, such as a put option, which gives the right to sell at a set price and creates a floor under the value of the holding. A collar combines a put with a sold call to reduce the cost but caps the upside, and businesses use forward contracts to lock in favourable exchange rates or commodity prices.
Locking in profits has costs, because selling may trigger capital gains tax and any later rise is missed. Options cost a premium, and stop orders can be triggered by a brief dip before the price recovers.
The right approach depends on the investor's goals, time horizon and tax position. Discipline matters too.
Many investors hold winners too long because they hope for more, then watch the gain disappear. A written rule, such as selling a portion once a gain reaches a target, removes some of the emotion from the decision.
In practice
Real-world examples.
Example
A retail investor sees a technology stock double over a year. She sells a third of her holding to recover her original investment and lets the rest run. Whatever happens next, she cannot lose her starting capital.
Example
An importer has a contract to pay for goods in euros in six months, and the exchange rate currently favours him. He buys a forward contract to fix today's rate. If the euro strengthens, he is protected, although he would miss out if it weakened.
Example
A fund manager holds a share that has risen 60% and does not want to sell for tax reasons. She buys a put option to protect most of the gain. The premium is a cost, but the portfolio is protected against a sharp fall.
Formula
Calculation
Locked-in gain = (Sale price - Purchase price) x Number of shares sold
An investor bought 1,000 shares at $40, and they now trade at $55. She sells half, 500 shares, locking in 500 x ($55 - $40) = 500 x $15 = $7,500. For the remaining 500 shares, she sets a trailing stop 10% below the peak price of $55, which is $55 x 0.90 = $49.50. If the stop is triggered, she sells at about $49.50 and secures a further 500 x ($49.50 - $40) = 500 x $9.50 = $4,750. Her total locked-in gain would then be $7,500 + $4,750 = $12,250.Case study
Seen in the real world.
Halden Growth Fund is an illustrative, fictional investment fund that held a position in a mid-sized manufacturer. The shares had risen from $20 to $50 in eighteen months, and the position had become 12% of the fund.
The investment committee did not want to sell everything because the company's order book was strong, but it was concerned by a stretched valuation. It sold 40% of the position at $50, locking in a gain of $30 per share on that portion, and put a trailing stop 12% below the high on the remainder.
Three months later, an industry slowdown pushed the shares down to $38, triggering the stop at about $44. The fund had secured gains on the whole position. Had it done nothing, the fall would have cut a large part of the profit.
Watch out
Common mistakes.
- Locking in profits too early on every winner, which caps the long-term return of a portfolio.
- Ignoring tax, because a sale can create a tax bill that reduces the gain you thought you had secured.
- Using a tight stop in a volatile stock, so that normal price swings trigger a sale.
Questions
People also ask.
Is locking in profits the same as taking profits?
They are very close, though locking in can also mean protecting a gain with hedges or stops without selling.
How much of a gain should I lock in?
There is no fixed answer, but many investors sell a portion at set targets, such as when a position doubles, to reduce risk.
Does locking in profits guarantee I make money?
It secures the gain already made, but any later move is missed, and the trade has costs such as commissions, tax and option premiums.
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