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Realized Versus Unrealized Returns - Never Generate Errors On Your Account!
Traders handle two various kinds of returns when they refer to profits and losses produced in the markets. Realized returns, generally referred to as "booked", are those that come about as the result of a position that was closed out.
Unrealized, or "paper", returns and losses are those which involve open positions. A good example of a paper return would be when one acquires a stock at $100 and it goes up to $110, but the trade remains open. In this case the trader has an unrealized return of $10. Were the trade to become closed out at that value, that $10 gain would turn into a realized, or booked, profit.
While it might seem a fairly trivial point, the concept of paper verses booked returns is a very important one inside the realm of trading and money management.
Debates are typically had as to whether or not paper losses are real, or whether or not they only become real if actualized. This is a key distinction that may play a major role in one trade, based on the market in question.
Where one is trading mainly in cash terms in a market like stocks, the difference between paper and booked returns isn't incredibly significant. No matter how much the market moves in either favor or against a trader's open position, it does not impact her/his capacity to enter further trades.
When one trades a market like futures and spot foreign exchange, however, there actually is no such thing as paper returns mainly because these markets are dependent on margin. Therefore, all profits and losses are realized because they directly effect one's available margin.
Understanding the influence of realized and unrealized returns is something key inside the development of both money management schemes and trading strategies. Want extra support?
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Failure to realize how these distinctions play-out in one's account can lead to major errors within the assumptions underlying position sizing, and exposure. It can mean the distinction between a successful system and a useless one, or between a safe risk profile and a reckless one.
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