What Is a Take Profit Order and How Does It Work?
Optimize your trading strategy. Learn how take profit orders help you secure gains and manage profitable positions effectively.
A take profit order is a specific instruction given by a trader to a brokerage to automatically close an open investment position once a predetermined price level is reached. This type of order is designed to secure gains from a favorable market movement. It acts as a predefined exit point for a trade, ensuring that any accumulated profits are locked in before market conditions potentially reverse. By setting such an order, traders aim to capitalize on anticipated price increases without needing to monitor the market constantly.
What is a Take Profit Order
A take profit order functions as a type of limit order, instructing a broker to execute a trade at a specified price or better, representing a desired profit level. Its fundamental purpose is to automatically close a profitable trade. This mechanism allows investors to secure gains at a predetermined point, preventing potential profits from diminishing if the market reverses direction. The order ensures that once an asset’s price hits the target, the position is closed, converting unrealized gains into actual funds. This tool is useful for locking in earnings without continuous market observation. It remains active until the market price reaches the specified take profit level, at which point it is triggered for execution.
How Take Profit Orders Work
The practical application involves setting a specific target price at which a profitable position should be closed. For instance, if a trader buys a stock at $100 and believes it will reach $110, they can place a take profit order at $110.
Once the market price of the asset reaches the specified take profit level, the order automatically triggers. The brokerage system converts the take profit order into a market order or a limit order to close the position. For a long position, the shares are automatically sold. Conversely, for a short position, the asset would be automatically bought back. This automated execution ensures the profit is realized without requiring the trader’s constant attention.
For example, if a trader purchases 500 shares of a company at $20 per share and sets a take profit order at $22, the system will automatically sell those 500 shares if the price reaches $22. This action locks in a profit of $2 per share, totaling $1,000 for the entire position.
Why Use a Take Profit Order
Employing a take profit order offers a structured approach to managing investment outcomes. It helps traders secure gains by automatically closing positions at predetermined profitable price levels. This is beneficial in dynamic markets where prices can fluctuate rapidly, ensuring profits are captured at the opportune moment and reducing the need for continuous market monitoring.
This type of order also helps remove emotional influences from trading decisions. Traders might otherwise hold onto a winning position for too long out of greed, hoping for even greater returns, only to see prices reverse. A take profit order ensures a disciplined exit, preventing potential gains from being lost due to indecision or market shifts. It provides a clear exit strategy, allowing traders to focus on other opportunities rather than constantly watching a single trade.
Take Profit Orders vs. Stop-Loss Orders
Take profit orders and stop-loss orders are both tools for managing risk in trading, but they serve distinct purposes. A take profit order locks in gains by automatically closing a position when the market moves favorably and reaches a specified profit target. It ensures that a trade exits with a gain once the desired return is achieved.
In contrast, a stop-loss order is implemented to limit potential losses. It automatically closes a position if the market moves unfavorably, reaching a predetermined price level that indicates an unacceptable loss. While a take profit order focuses on securing profits, a stop-loss order acts as a protective measure against significant capital erosion. Together, these two order types complement each other, providing a comprehensive strategy for managing both the upside and downside risks of a trade.