A take profit order is a standing order to sell a security once it reaches a certain level of profit. Selling at this price ensures that the trader will make a profit on the trade.
Learn how a take profit order works to minimize risk and who should use one.
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 is 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 name: Take-profit order, limit order, sell limit order3
- 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 onto the securities.
How Does a Take Profit Order Work?
To use a take profit order, day traders establish 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 traders 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 a share. The trader has good reason to believe that the stock will go up during the trading days, so they will put in a take profit order that specifies that once the stock reaches $8.50 a 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 taking profit orders helpful if you are a trader with a short-term strategy. Using one allows day traders 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). The ADX 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 a trend is strong and you should not use a take profit order.
- Levels below 20 indicate a trend is weak and taking profit orders may be a good idea.5
Pros and Cons of Taking 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.