Understanding Take-Profit Orders: Definition, How they Work, and Examples
A take-profit order is a key tool for securing profits in trading. While stop-loss orders help minimize potential losses, take-profit orders ensure you lock in gains at the right moment.
Understanding how, when, and where to set these orders is crucial for enhancing your trading performance. Let’s explore the best practices for placing take-profit orders effectively.
Key Takeaways
A take-profit order allows the investor to automatically take profits when a previously established price level (the limit) is reached.
Technically, a take-profit order is a limited order in the opposite direction but equal in size to the open position it must close.
A take-profit order can only be partially executed or never be executed!
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What is a take-profit order?
A take-profit order is a stock market order that aims to close an open position so that the investor can pocket their earnings.
From a technical perspective, a take-profit order is a limited order in the opposite direction but equal in size to the open position it must close.
How a take-profit order works
A take-profit order is tied to a price set by the investor: the limit. When the market price reaches the limit, the take-profit order is executed, and the position is closed automatically.
The position will be fully closed if all the shares offered at or above the limit are purchased. Otherwise, it will be partially closed, and the unexecuted portion will remain pending in the order book.
If prices never reach the limit, the take-profit order will not be executed, and the position will remain open until it has been manually closed or has hit its stop-loss order.
Under certain market conditions caused by quotation gaps, a take-profit order can be executed at an even more attractive price than the limit set by the trader!
At what price should you set your take-profit orders?
The take-profit order must be placed at the price calculated in your trading scenario, i.e., at the price that, if reached, will indicate that you were correct in your analysis.
Therefore, a seller take-profit order (intended to close a buyer position) is generally placed just below a resistance level which is likely to block a price rise or even lead to a price relapse.
Conversely, a buyer take-profit order (intended to close a selling position) is usually placed just above a support level which is likely to stop a price decline or even lead to a rebound.
Fibonacci retracement levels can also serve as benchmarks for positioning take-profit orders, especially in markets with clear trends.
The further the take-profit order is from the entry price, the lower the likelihood of reaching it, but the higher the potential for gain. Conversely, the closer the take-profit is to the entry price, the higher the likelihood of reaching it, but the lower the potential for gain.
Therefore, traders must choose between an ambitious goal, which reduces the likelihood of success but increases the potential gain by moving the limit away from the entry price, and a more modest goal, which increases the likelihood of success but reduces the potential gain by moving the limit closer to the entry price.
With scalping strategies, for example, traders choose a take-profit price very close to the entry price in order to maximize their success rate and accumulate small profits.
The limit is not set in relation to the value of the potential gain but according to the scenario predicted by the trader and the risk/return ratio sought on the transaction.
Why place a take-profit order?
Take-profit orders allow traders to take their profits automatically and turn their latent gains into realized capital gains. A bird in the hand is worth two in the bush!
Take-profit orders allow traders to manage their capital and transactions more effectively, optimizing specific performance indicators such as the profit factor.
But why not manually close your positions when you reach your trading scenario target? While this is a viable option, it has several drawbacks.
Without a take-profit order, traders would have to constantly monitor the market, requiring rigorous discipline and exposing them to unforeseen risks such as power outages or the internet being down. Using take-profit orders reduces the need for constant monitoring so they can trade more leisurely.
As brief as it may be, a price movement above your limit will guarantee that your take-profit will be executed. On the other hand, during the fraction of a second it takes to secure your profits manually, the market might move, and you might close at a lower price.
Should we always place take-profit orders?
Although it is used in most trading strategies, taking profit is not mandatory. Those who subscribe to the theory of “trend monitoring” forego taking a profit; they take advantage of the trend and let their gains run as long as possible.
The decision of whether to place take-profit orders or not should not be left to chance. It should be part of a well-thought-out process embedded in your trading plan!
How to place a take-profit order
Take-profit orders can be created when you open a position or any time thereafter. The best paper trading platforms show the take-profit prices right on your charts!
How to edit a take-profit order
Most trading platforms allow you to modify the take-profit level associated with a current position right from your chart.
How to cancel a take-profit order
Suppose the take-profit order was initially created when the position was opened. In that case, it is usually canceled automatically when the position is manually closed or when the stop loss is reached.
As for open positions, your take-profit order can be canceled at any time.
Take-profit orders are an essential money management tool. If you want to master how take-profit orders work and how to maximize placing them, spend as much time as you need practicing on a trading simulator.
Maxime holds two master’s degrees from the SKEMA Business School and FFBC: a Master of Management and a Master of International Financial Analysis. As founder and editor-in-chief of NewTrading.fr, he writes daily about financial trading.
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