Definition and Example of a Target Profit Order
A target profit order is a fixed order to sell a security when it reaches a certain profit level. Selling the security at this price ensures that the trader will make a profit on the trade.
An example of this is when a trader buys a share at $5.25 per share and sets the target profit order at $8.50 per share. If the share price reaches this point, the sale will be executed automatically. If the price does not reach this point, the order will not be executed, and the trader will continue to hold the security.
How Does a Target Profit Order Work?
To use a target profit order, the trader sets a price at which they want to sell the security. This price must be high enough above the purchase price of the security to ensure the trader makes a profit from the sale.
Placing a target profit order requires technical analysis of the security’s value and predicting market movements. Some strategies for calculating an appropriate target profit order include:
- Average True Range plus the previous day’s high
- Daily or weekly pivot point
- Chart pattern analysis
A target profit order is an automatic exit strategy based on profit and loss calculations rather than an emotional decision to sell or hold the security.
Do I Need a Target Profit Order?
You may find a target profit order useful if you trade with a short-term strategy. It allows the trader to exit the market as soon as it reaches the day’s profit goal.
Typically, a target profit order is better for traders with short-term strategies. Short-term traders without a specific profit goal may find that the profits they achieve fade quickly if they do not have a good understanding of when to exit.
Many indicators can help you see market trends and assess whether a target profit order is a good idea. One useful indicator for new traders is the Average Directional Index (ADX), which shows the strength of a trend on a scale from 0 to 100. The weaker the trend, the more likely it is to change. Levels above 40 indicate that the trend is strong, and a target profit order should not be used. Levels below 20 indicate that the trend is weak, and a target profit order may be a good idea.
Advantages and Disadvantages of a Target Profit Order
Advantages:
- Profit Guarantee: The target profit order is set to ensure that the trader achieves a certain level of profit. If your order is executed, you are guaranteed to make a profit on the trade.
- Risk Reduction: A target profit order allows you to take advantage of a quick rise in the market instead of the chance of missing out on selling for a profit.
- No Doubt: Traders using target profit orders do not need to decide whether it is better to buy or sell at the moment. Trading occurs automatically without the risk of second-guessing the decision.
Disadvantages:
- Not Suitable for Long-Term Traders: Target profit orders are a short-term strategy to ensure a specific level of profit quickly. They are not suitable for long-term traders who prefer to endure more market volatility for potentially greater profits in the long run.
- Missed Trends: Target profit orders do not allow traders to take advantage of long-term trends. Traders who use profit targets often feel frustrated when they identify a good trend and exit too early.
- May Not Be Executed at All: Placing a target profit order does not guarantee that the sale will occur. If the market does not rise to the designated level, you may have to sell at a loss.
By understanding the advantages and disadvantages of a target profit order, you can determine whether this strategy is right for you in trading.
Source:
https://www.thebalancemoney.com/what-is-a-take-profit-order-1344975
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