With the help of a take profit order, investors can realize their profits before corrections or price drops occur. Together with the stop-loss order, it forms the classic hedge for short-term investment strategies. However, finding the right measure for a take profit order is not that easy. We explain how you can use this type of order sensibly and what you should bear in mind when using it.
Take Profit Order Definition
A take profit order is an order that is executed to realize a profit. It is executed when the respective asset has reached a predefined price. A market order is then placed and the position is sold.
Thus, the take profit order corresponds to a market order (immediate execution, regardless of the price) with an upstream condition. Execution takes place only if a price set by the investor has been reached.
Unlike other, conditional order forms (limit order, stop order, ...), however, this price is not an absolute euro value, but a percentage. For example, a take profit order can be set for "15 % above the current price".
Only when the price of the respective asset has recorded a gain of 15 %, the take profit order is triggered and the corresponding order (buy or sell) is executed.
As its name suggests, the take profit order is ideal for "taking" profits. Once the specified price increase has been achieved, the position is automatically closed.
Together with the stop-loss order, which has the exact opposite function and is intended to avoid losses, the take-profit order is a classic investment hedge. Investors can use them to automate the payment of profits and avoid manual (and thus often emotional) decisions.
However, when betting, pay attention to the possible disadvantages: A take profit order can lead to a premature exit if the price limit was set too low. The respective asset may subsequently show further growth, in which we are no longer involved after the execution of the take profit order. For investors who follow a long-term strategy (for example, value investing, buy-and-hold, ...), this order form is therefore rather unsuitable.
In addition, price fluctuations may occur due to execution as a market order. Since the transaction is executed immediately, at the best available price, the actual buy/sell price may differ from our target value.
Apply take profit orders correctly
In short-term strategies such as day trading or scalping, hedging profits with a take profit order is practically unavoidable. It ensures that price gains are realized in time.
Together with the loss hedging by the stop-loss order, it also serves to determine the risk-reward ratio (CRV). To do this, we simply set the potential of a trade, represented by the take profit order, in relation to the possible risk, represented by the stop loss order.
A typical rule of thumb in the financial markets is that the ratio of potential to risk should be 2 to 1. Our take profit order must therefore have at least twice the volume of our stop loss order. Other ratios are of course also possible and can make sense, depending on the strategy.
When creating a take profit order, be sure to set the price that suits you. The lower your limit is set, the more profit you will miss out on if there is a sharp rise in the price, as you will already have exited early.
On the other hand, if your price level is set too high, the price might reverse even before your limit is reached and your profit might vanish into thin air. If you expect a very strong price increase, it may make more sense to work with other order forms (e.g. trailing stop loss).
Take Profit Order Example
You have targeted a stock with high volatility and want to earn from its strong fluctuations. You therefore buy 100 Securities for a price of 20 euros and immediately provide this position with a stop-loss order to hedge losses and a take-profit order to realize profits.
Based on your observations of the stock, you consider a value of 20 % for the price limit to be ideal and specify this in your take profit order. In fact, within a few days, the stock reaches a price gain equal to 20 % of your purchase price.
Your take profit order is triggered by this and your broker places a market order to sell your shares, as specified. The execution takes place immediately at the best available price, which in this case corresponds to 23.90. You will therefore be credited with 2,390 euros and have thus made a profit of 390 euros.
The share then continues to move upwards for some time. If you had not used a take profit order or set a higher price limit, your profits would have been even higher. A short time later, however, the share price collapses and falls far below the original value of 20 euros. Your take profit order saved you from this collapse and gave you a more than solid return.