What Is Profit-Taking?
Profit-taking is selling a security to lock in gains after it has risen appreciably. Profit-taking can affect an individual stock, a specific sector, or the broad financial market.
A profit-taking event may lead to an unexpected decline in a stock price or equity index. External forces such as company news or market data may trigger profit-taking.
Key Takeaways
- With profit-taking, an investor cashes out gains in a security that has rallied since the time of purchase.
- Profit-taking benefits the investor taking the profits, but often pushes the stock price lower in the short term.
- Profit-taking can be triggered by a better-than-expected quarterly report or analyst upgrade.
Selling Triggers
Profit-taking can affect any advancing investment, such as stocks, bonds, mutual funds, or exchange-traded funds (ETFs). A specific catalyst often triggers profit-taking, such as a stock moving above a price target; however, profit-taking may also occur simply because the price of a security has risen sharply in a short period.
The quarterly or annual earnings report like SEC Forms 10-Q or 10-K triggers profit-taking in a stock. A stock may be more volatile in the weeks surrounding the period when the company reports results. Traders may take profits even before the company reports earnings to lock in gains, rather than risk profits dissipating if the earnings report disappoints.
Investors may also take profits after earnings are reported to prevent further declines if the company has missed expectations on earnings per share (EPS), revenue growth, margins, or guidance.
A take-profit order (T/P) is alimit orderspecifying the exact price to close out an open position for a profit.If the price does not reach the limit price, the order will not be filled.
Sector vs. Broad Market
Profit-taking in a specific sector—even against a strong bull market—could be triggered by an event specific to that sector. For example, a bellwether stock could report unexpectedly weak earnings in an otherwise hot sector, which may trigger profit-taking across the entire sector. A promising tech company with a poor initial public offering (IPO) may drive investors to exit the sector.
Profit-taking in the broad market is usually a result of economic data, such as a weak U.S. payroll number, high levels of debt, or currency turmoil. In addition, systematic profit-taking could occur due to geopolitical reasons, such as war or acts of terrorism.
How Does an IPO Affect Profit Taking?
When a company begins trading with a potentiallyhot IPO, the share price can spike during the first trading day but fall rapidly. This commonly occurs due to the large number of market orders at the open, followed byprofit-takingby buyers who have their trades filled early and then profit from the run-up in price.
How Long Does a Period of Profit Taking Last?
Profit-taking is typically a short-term phenomenon. The stock or equity index may resume its advance once profit-taking has run its course. However, a concerted effort of profit-taking that knocks a stock or index down by several percentage points could signal a fundamental change in investor sentiment and portend additional declines to come.
How Does Profit Taking Affect a Stock's Long Term Price?
If the profit-taking is one-time event-driven—such as in response to an earnings report—the overall direction of the stock is unlikely to change long-term. If the profit-taking is driven by a bigger issue such as economic policy, long-term stock price weakness may occur.
The Bottom Line
When an investor sells a security that has increased in value since its purchase, it's called profit-taking. Profit-taking events may push the stock price lower in the short term. Profit-taking can be triggered by a company's quarterly or annual report, an analyst upgrade, or a macroeconomic event.
FAQs
Meaning of profit-taking in English
a situation in which people sell shares, etc. after prices have risen, in order to make a profit. This often causes prices to fall: Crude oil prices weakened amid profit-taking after a three-day rally.
What is an example of taking profit? ›
Take-Profit Order Example
The trader might create a take-profit order that is 15 percent higher than the market price in order to automatically sell when the stock reaches that level. At the same time, they may place a stop-loss order that's five percent below the current market price.
Is profit-taking a good strategy? ›
Take-profit levels along with stop-loss levels help you achieve consistency and push you to follow your trading plan.
What happens when you take profit? ›
Profit-taking is selling a security to lock in gains after it has risen appreciably. Profit-taking can affect an individual stock, a specific sector, or the broad financial market. A profit-taking event may lead to an unexpected decline in a stock price or equity index.
When should you take profits? ›
When a stock is going the right direction, your decision making is not as easy. How long should you hold? Here's a specific rule to help boost your prospects for long-term stock investing success: Once your stock has broken out, take most of your profits when they reach 20% to 25%.
How does take profit work? ›
A Take Profit (TP) order is a type of trading order that instructs a broker to close a position once the market reaches a specified profit level. This order type allows traders to lock in their gains automatically, without having to constantly monitor their open positions.
What is the 3-5-7 rule in trading? ›
The 3–5–7 rule in trading is a risk management principle that suggests allocating a certain percentage of your trading capital to different trades based on their risk levels. Here's how it typically works: 3% Rule: This suggests risking no more than 3% of your trading capital on any single trade.
What is the 20 profit-taking rule? ›
20%-25% profits-taking rule
When the stock price goes up and reaches that percentage, you sell the stock to secure your gains, which will also boost your confidence in further investment.
Can you take profit without selling stock? ›
Using the demat value of the shares as margin for trading
This is the simplest method of monetizing your shares without actually selling them. Typically, your broker will allow you to take a margin trading position in the equity or even the F&O segment based on the value of your demat holdings.
What is the 7 percent sell rule? ›
The 7% stop loss applies to any stock purchase at any level. If you bought a stock at 45 and the buy point was at 43, you want to calculate the 7% sell rule from your purchase price.
You don't need to hit home runs to win the investing game. Focus on getting base hits. To grow your portfolio substantially, take most gains in the 20%-25% range.
What is the best take-profit strategy? ›
A very popular profit-taking strategy, equally applicable to option trading, is the trailing stop strategy wherein a pre-determined percentage level (say 5%) is set for a specific target. For example, assume you buy 10 option contracts at $80 (totaling $800) with $100 as profit target and $70 as a stop-loss.
How do you calculate profit taken? ›
The basic formula that is used to calculate the profit in a business or a financial transaction, is: Profit = Selling Price - Cost Price. Here, Cost Price (CP) of a product is the cost at which it was originally bought. Selling Price (SP) of the product is the cost at which it was is sold.
How do you calculate profit-taking? ›
To calculate the take profit level, subtract the stop loss level from the entry price, then add the result to the entry price. This will give you the price level at which you should take your profit to maximize your potential return while minimizing your risk.
What is the best take profit ratio? ›
When you set a Take Profit, you should take into consideration a Risk/Reward ratio. This measure shows how much profit a trader anticipates in exchange for a risk of a limited loss. In general, the best ratio is 1:3, so the profit should be 3 times bigger than the loss.
