Definition and Example of a Take-Profit Order
A take-profit order is a standing order put in place by traders to maximize their profits. It specifies a certain price above the purchase price, which is chosen by the trader. If the price of a security reaches that limit, it will automatically trigger a sale. If the price does not reach that limit, the order will not be not acted on.
A take-profit order is a short-term trading strategy. It is useful for day traders who want to take advantage of a quick rise in the cost of securities to make an immediate profit. It is a type of limit order, though limit orders can be used to either buy securities at a low price or sell them at a high price.
- Alternate names: Take-profit order, limit order, sell limit order
- Acronym: T/P order
Once the take-profit point is reached on a stock that a trader owns, the order is triggered, and the sale goes through at that day's current market value. If that point isn't reached, the sale is not executed, and the trader holds on to the securities.
A take-profit order is often used with a stop-loss order. This is a similar standing order that triggers a sale when the price of a security drops to a certain level. It minimizes, or stops, the loss that the trader can experience.
How Does a Take-Profit Order Work?
To use a take-profit order, a day trader establishes a price at which they want to sell a security. This price is one sufficiently above the price at which the security was bought, to ensure that the trader will make a profit on the sale.
For example, a day trader may have 1,000 shares of a stock that were purchased at $5.25 per share. The trader has good reason to believe that the stock will go up during the course of the trading day, so they will put in a take-profit order that specifies that once the stock reaches $8.50 per share, a sale of that stock will be automatically triggered.
A T/P order allows you to limit your risk or exposure to the market by exiting your trade as soon as the market prints a favorable price for you, and not staying in any longer.
Setting a take-profit order requires a technical analysis of the security's value and the likely movement of the market. Some strategies for calculating an appropriate take-profit order include:
- The average true range plus an overnight extreme
- A daily or weekly pivot point
- Chart pattern analysis
A T/P order is an automatic exit strategy based on a profit-loss calculation rather than an emotional decision to sell or hold.
Do I Need a Take Profit Order?
You may find take profit orders helpful if you are a trader with a short-term strategy. Using one allows a day trader to exit the market as soon as they reach their profit goal for the day.
Often, the shorter-term a trader's strategy is, the better a take-profit order is for that trader. Short-term traders without a take profit target may quickly see the gains they make slip away if they do not have a good understanding of when to exit.
Many indicators can help you see trends in the market and judge whether a take-profit order is a good idea. One that is helpful for new traders is the average directional index (ADX), which shows how strong a trend in value is on a scale of zero to 100. The weaker a trend is, the more likely it is to change.
- Levels above 40 indicate that a trend is strong and that you should not use a take-profit order.
- Levels below 20 indicate that a trend is weak and that a take-profit order may be a good idea.
Pros and Cons of Take-Profit Orders
Every trader is willing to accept a different level of risk, and every trader has different goals and timelines that they work with while trading. Understanding the pros and cons of a take-profit order will help you understand whether it is the right trading strategy for you.
- Ensure a profit
- Minimize risk
- No second-guessing
- Not good for long-term traders
- Can't take advantage of trends
- Might not be executed at all
- Ensure a profit: A T/P order is set to ensure that a day trader makes some level of profit. If your order is executed, you are guaranteed to make money on the trade.
- Minimize risk: A take-profit order allows you to take advantage of a quick rise in the market rather than potentially missing the chance to sell at a profit.
- No second-guessing: Traders who use T/P orders don't have to decide whether it is better to buy or sell in the moment. The trade happens automatically without the risk of second-guessing the decision.
- Not good for long-term traders: Take-profit orders are a short-term strategy to guarantee that you make some level of profit quickly. They aren't appropriate for long-term traders who are willing to tolerate more ups and downs in the market in order to make a larger profit in the end.
- Can't take advantage of trends: Take-profit orders don't allow you to take advantage of longer-term trends. Trend traders who use take profit targets are often frustrated when they’ve recognized a good trend and get out too early.
- Might not be executed at all: Having a take-profit order in place doesn't guarantee that the sale will happen. If the market never rises to the T/P level you set, you may still have to sell at a loss.
- A take-profit order is a standing order to sell a security once it reaches a certain level of profit.
- If that point isn't reached, the sale is not executed, and the trader holds on to the securities.
- Take-profit orders are a short-term trading strategy that allow day traders to take advantage of a quick rise in the market to make an immediate profit.
- Using one minimizes your risk and avoids emotional decision-making in the moment.