Stock market trading always involves certain risks. Investors who follow a long-term investment strategy rarely pay attention to current price fluctuations. They focus on the inevitable growth of the stock market and are confident in making a profit at the end of the planned investment cycle. For those engaging in speculative operations, short-term gains, and working on declining asset prices, such fluctuations can bring many troubles. Both losses and missed profits are equally critical for them. Stop orders help combat these issues: stop-loss in the first case and take-profit in the second.
Take Profit is an order that the trader sends to the broker along with the execution of a trade on an instrument. This order instructs the broker to execute a reverse transaction (sell the asset if it was bought, buy it if it was sold) when the profit level reaches the specified amount. Setting such an order allows the trader/investor to set a goal for a particular trade and lock in profits when the price moves in the desired direction.
A simple example illustrates the use of a take-profit. An investor buys 100 shares of company XXX at $100 each. They expect the price to rise and reach $120 per share. Further growth, in their opinion, is questionable. Along with the buy order, they instruct the broker to set a Take Profit order at $120. The prices rise and reach the specified level. The order triggers, the shares are sold, and the investor earns $2,000 in profit. Any further price increase does not bring additional income since they are out of the market after selling the shares. They are also unconcerned about an alternative scenario where the asset price bounces back from the $120 level: the profit is already locked on the broker’s account.
Some traders and investors consider setting a Take Profit order for locking in profits irrational. They argue that it results in missed profits if the price continues to rise after reaching the set limit. However, with the correct choice of the order level, a bounce is a more likely scenario. In this case, the missed profit can be significantly higher. During a deep correction or trend reversal, there is a risk of turning a profitable position into a losing one. In a strong trend, nothing prevents a new trade in the chosen direction after locking in profits.
How to Set a Take Profit?
Modern trading platforms allow setting Take Profit in several ways:
- Specify the asset price level at which the reverse trade will be executed.
- Indicate the change in instrument quotes (usually in points or fractions of points) at which the position will be closed.
- Set the profit level in monetary terms (usually in the currency in which the instrument is quoted or the funds on the broker’s account are calculated), upon reaching which the existing position will be liquidated.
On any trading platforms and terminals, take-profit has common properties:
- It can be set for positions opened in any direction (both for buying and selling);
- It is always placed at a better price than the current market price, i.e., for buying assets, take-profit can only be set above the current quotes; for selling, below;
- It is a limit order, so it appears in the order book (but not distinguished from others) and is executed at the price equal to or better than the specified price.
Some trading platforms have limitations on setting Take Profit, including:
- Minimum distance in points from the current market price;
- Minimum allowable distance from the opening price of the trade (rarely applied).
Some trading software (especially web implementations) does not support the setting of Take Profit orders at all, which does not restrict the trader from placing such orders manually. To do this, simply choose the profit-locking level and set a limit order at that level in the opposite direction of the open position.
Manually setting Take Profit orders has advantages over built-in terminal features. Typically, terminals only allow automatic placement of Take Profit orders in volumes equal to the open position size. Manually, a trader can use multiple levels with volume splitting. In the example above, they could create counter orders to sell 50 shares at $110 and another 50 at $120. This would allow them to partially lock in profits when the quotes rise by just 10 points.
When to Use and How to Choose the Right Take Profit Level?
As mentioned earlier, for portfolio investors working with a long-term perspective, using take-profit doesn’t make sense. It is mainly used by those who engage in short-term operations hoping to increase profits through asset price fluctuations. Generally, profit locking is an essential part of the following trading strategies:
- Scalping strategies.
- Trading strategies based on support/resistance levels.
- Intraday or short-term strategies using technical analysis indicators and some chart patterns (e.g., Gartley butterfly).
Each of these trading systems uses its approaches to calculating the profit-locking level. Some of these methods are universal and can be used in almost any market situation.
Recommendations for placing Take Profit:
- It is advisable to place Take Profit near strong support/resistance levels. First, these levels act as “magnets” for the price (there is a high probability that quotes will reach them). Second, breaking through such levels rarely happens immediately, providing a good opportunity to lock in profits and re-enter the market when corresponding signals appear.
- The profit level (Take Profit setting) should exceed the allowable loss by 2–3 times or more. In this case, one profitable trade covers the losses from several losing ones, and the expected value allows for profitable trading over the long term.
The order must be set if it is stipulated by the trading system’s algorithm. Violating this rule can lead to significant losses or missed profits.