What is a Take Profit Order?

Once you have been trading for a while, you’ll make trades that are profitable. While this is great news, the next step is to determine when you want to exit the trade. This step can often be as difficult as entering a trade. A take-profit order can help ease some of these difficulties and make you a better trader. 

A take-profit order is a type of order that is used to close out an open position. It will automatically execute a trade at a given price if the underlying security is at or above a certain price level. The take-profit order can be created when you enter a trade and allows you to manage risk in a systematic and standardized way. 

Here’s an example — a trader believes that Apple will release positive news about its new iPhone model next week. The trader believes that the price will rise 5% on news, based on technical analysis or a general feel for the security. To express this view, the trader enters into a long Apple position by purchasing shares. The trader also sets a take-profit order at 5% above the current market price. When next week comes and the positive news is released, Apple stock rises 5%. The take-profit order is automatically filled and the trader makes 5%. With the take-profit order, the trader did not have to worry about the psychological factors of trading or actively watching the stock’s every move. Instead, they set predefined risks and take a more hands-off approach. 

Follow three main steps to set up a take-profit order for your next trade.

• Select the desired price target: Setting a price target determines how much the trade could potentially make. It is important to select a price that is not too high but not a price that forces you to lose out on potential gains. 
• Choose the appropriate order: A take-profit order is often combined with a stop-loss order to further specify risk. 
• Setting the order duration: Depending on the broker you trade with, you may also be able to set a duration for your take-profit order. Going back to the previous example, if Apple ends up not releasing news in the next week and you do not have a view on what will happen after that, a duration on the order might be a good idea. This parameter can be used to further tailor your risk management profile for each trade. 

• Limit Order: A limit order allows traders to set a predetermined price at which they want to trade a security. If the price touches the limit, then a buy or sell order will be placed. A take-profit order is a type of limit order in which you set a price to sell in the future. 
• Stop Loss: A stop-loss order is another type of limit order. It is essentially the opposite of a take-profit order. It will close out a position if the trade loses a predetermined amount of money. 
• Market Orders: Market orders are the most basic type of trade. When you place a market order, you are agreeing to buy or sell the security at the current price. While this will almost always allow you to enter a trade, it may cause you to get a worse entry than if you did a limit order. 
• All or None (AON): Another dimension of orders is the amount. All or none orders specify that the entire order must be completed and it cannot be partially filled. This is especially relevant for large order sizes and ensures that you are able to enter the trade in the entirety of the specified quantity. 
• Good ‘Til Canceled (GTC): The timeframe is another consideration to make when placing an order. Good ‘til canceled means that the order will remain active and could potentially get filled at any time unless the order is canceled by the trader. The alternative to this is a day order, which is automatically canceled at the end of the trading day. 

The main advantage of a take-profit order is that it creates a structure for the trade. By setting a level at which you are comfortable exiting the trade beforehand, it can remove the psychological component of trading. As the psychology of trading can often lead to downturns in profits, this structure can allow traders to better manage their risk. 

Additionally, the orders are also automated through the broker, allowing the trader flexibility in terms of monitoring the position. They do not have to constantly watch the price and try to determine the best time to close the position.

While take-profit orders can be a great tool to manage risk, it is important to understand their limits and some common mistakes beginners can make. 

One major mistake is setting unrealistic price targets. While it can make the trade look profitable if the price were to reach that level, it is important to be realistic in choosing price targets so that you have a greater chance of exiting the trade and securing a profit. 

Another mistake is that traders may not adjust their take-profit level as market conditions change. The best traders are able to adapt to the markets. One way of adapting is by adjusting your take-profit levels as the price moves. For example, if you are feeling less confident in your trade thesis, it may be a good idea to lower your take-profit level so that you increase the likelihood of exiting the trade before taking losses.

Many beginning traders may not take into account liquidity when creating take-profit orders. Just because the price touches the take-profit level does not mean that the order will be filled. There has to be enough liquidity in the market to field and execute the order. While this is likely not going to be an issue for liquid securities (mega-cap stocks), it could become a consideration for less liquid securities (penny stocks, options).

You can avoid some of the common mistakes made surrounding take-profit orders. For starters, you can review and adjust your take-profit orders regularly to adjust with the markets while maintaining structure to the trade. Consider the level of the take-profit order in comparison to how the security has moved in the past to form an educated thesis on a potential order level. Look at the liquidity of the underlying as another piece of information that can contribute to the price level of the take-profit order. 

Markets move quickly, and it can be hard to both keep up with and make decisions on the fly. Take-profit orders are designed to remove some of these psychological elements to give traders a more systematic way to trade. If you struggle with the emotional side of trading, trying out take-profit orders could be a great idea.