Lesson 3 of 25 · 6 min

Treating an unrealised gain as spent

The market can take back a paper profit, and it cannot take back the draw taken against it.

An unrealised gain is a subtraction between two prices, one of which is still moving. A loan drawn against it is a fixed number that only ever grows. The two are usually held in mind as the same substance, and they behave nothing alike.

Take 4,280 shares bought at $61.50, a cost of $263,220. At $158.40 the position is worth 4,280 × $158.40 = $677,952, so the unrealised gain is $677,952 − $263,220 = $414,732. A draw of a quarter of that gain is $414,732 × 0.25 = $103,683. At the moment of the draw the framing is easy to hold: a fraction of a profit has been spent, and three quarters of it remains.

Then the price falls 29.0 percent to $112.46. The position is worth 4,280 × $112.46 = $481,329, and the gain is $481,329 − $263,220 = $218,109. The gain has fallen 47.4 percent. The loan has not moved at all, other than upward with accrued interest. The $103,683 that was a quarter of the gain is now $103,683 ÷ $218,109 = 47.5 percent of it.

This is what mental accounting does with a paper gain: it books the gain into an account labelled winnings, spends from that account, and continues to treat the account as separate from the position that produces it. The account has no balance. It is a difference between the mark and a historical purchase price, and the mark is set by strangers every trading day.

The gain floats and the loan does not. Nothing about the draw goes backward when the price does.

Key terms

Unrealised gain: The difference between the current mark and the cost of a holding, before any sale. It changes every day the market is open.
Realisation: The sale that turns a difference between prices into cash. Until it happens the gain is a quotation, not an amount held.
Fixed claim: An obligation denominated in currency rather than in shares. It does not shrink when the collateral does.

Worked example

A quarter of the gain becomes half of it

4,280 shares bought at $61.50. Price rises to $158.40, then falls 29.0 percent to $112.46.

Cost of the position: $263,220
Gain at $158.40: $414,732
Draw of one quarter of the gain: $103,683
Gain at $112.46: $218,109
The same draw, as a share of the gain: 47.5%

The gain fell 47.4 percent and the draw did not fall at all. A quarter became almost a half without a single decision being made.

Check yourself

You draw $103,683 against a position when its unrealised gain is $414,732. The gain later falls to $218,109. What proportion of the remaining gain has been drawn, and what caused the change?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.