What it means
When an investor buys a share, the aim is to sell at a higher price. A take-profit order puts that aim in writing: sell if the price reaches this level.
When the market touches the level, the order triggers and the position is closed. The main benefit is discipline.
Prices rise and fall, and it is easy to hold on in the hope of more, only to watch a gain disappear. A pre-set target makes the exit a decision made calmly beforehand, rather than under pressure in the moment.
A take-profit order is often paired with a stop-loss order, which closes the position if the price falls to a chosen level. Together, they define the best and worst outcome of a trade before it starts.
The gap between the two sets the reward-to-risk ratio, which many traders insist should be at least 2 to 1. There are some nuances.
In a fast market the order may be filled at a slightly different price from the target, particularly if it is a market order once triggered. A target that is set too close will be reached often but leave little profit after costs, while one set too far away may rarely be hit.
For a company treasury, the same idea applies to selling a currency or a commodity position once a favourable rate is reached. The order does not guarantee a profit; it only guarantees that the exit will happen at the chosen level or better, when the market allows.
A sensible target is usually linked to something concrete, such as a recent price high, an analyst's valuation or a required return on the trade. Picking a number because it feels round is easy, but it gives no reason to believe the price will ever reach it.
Reviewing and adjusting the target as new information arrives is part of managing the position.
In practice
Real-world examples.
Example
A part-time investor buys shares in a utility company at $25 and sets a take-profit order at $28 before going on holiday. The price reaches $28 during the second week and the order sells automatically. When she returns, the profit is already banked.
Example
A company treasurer holds euros that were bought at a favourable rate to pay a supplier. She places a take-profit order to sell if the exchange rate rises 3%, which would protect the margin on the contract. The order is cancelled once the supplier is paid.
Example
A trader in oil futures enters a position and sets a profit target of $4 per barrel above the entry price. The market jumps through the target in the morning and the order fills. The trader avoids the afternoon reversal that would have removed most of the gain.
Formula
Calculation
Profit at target = (take-profit price - entry price) x number of shares - costs
Reward-to-risk ratio = (take-profit price - entry price) / (entry price - stop-loss price)
An investor buys 500 shares at $40.00, places a take-profit order at $46.00 and a stop-loss at $37.00. If the target is hit, the gross profit is (46.00 - 40.00) x 500 = 6.00 x 500 = $3,000. If costs are $50, the net profit is $2,950. The reward-to-risk ratio is (46 - 40) / (40 - 37) = 6 / 3 = 2.0, so the potential gain is twice the potential loss.Case study
Seen in the real world.
Quill & Pine Capital is an illustrative, fictional investment club with 20 members and a $200,000 portfolio. Members used to argue each month about when to sell winning positions, and several gains were lost while they debated.
The club's treasurer proposed a rule that every purchase would come with a take-profit order at 20% above the entry price and a stop-loss at 10% below. On a $10,000 purchase, that meant a target gain of $2,000 and a maximum planned loss of $1,000.
The illustrative outcome over a year was that seven positions hit the target, three hit the stop, and two were still open. The club's gains of $14,000 against losses of $3,000 were not guaranteed by the rule, but the arguments stopped and every exit had been decided in advance.
Watch out
Common mistakes.
- Setting the target so close to the entry price that costs and the spread consume most of the profit.
- Using a take-profit order without a stop-loss, which leaves the downside completely open.
- Assuming the order guarantees a fill at exactly the target price, when fast markets can cause slippage.
Questions
People also ask.
What is the difference between a take-profit and a stop-loss order?
A take-profit order closes a position at a gain, while a stop-loss order closes it at a loss to limit damage.
Is a take-profit order the same as a limit order?
It works like a limit order to sell above the current price, though trading platforms may label it separately when it is attached to an open position.
Does the order stay in place forever?
It remains active until it is filled, cancelled or reaches an expiry date set by the investor or the broker.
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