A take profit order is a type of order where an existing trade is closed when it reaches a certain level. It is a popular order type that is recommended in all types of trades.
In this article, we will focus on:
- what a take profit order is
- how you can use it well in the financial market
But, first, a little general review about orders.
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Types of orders in trading
A good way to understand this is to look at the various types of orders in the financial market. Broadly, there are two main types: limit and market orders.
Market Order → This is the most popular among retail traders. It is simply directing a broker to open a trade at the current market price. For example, if a stock is trading at $20, a market order will open it at that price right away.
Limit Order → This is an order type that does not open a trade immediately. Instead, it tells a broker to open a trade when the price reaches a certain level. For example, if the stock is trading at $20 and after some analysis, you find that the stock will reach a buy zone at $23, you can direct your broker to do that. This is known as buy stop order.
If you want to short it at $18, that is known as a sell stop order.
On the other hand, if you want to buy the shares at $18, you can set a buy limit order and if you want to short it at $23, you can set a sell-stop order. These order types are important in risk management and saving time.
For one, you don’t need to stay in front of your computer to fill an order.
What is a take profit order?
A take profit order is an order that directs a broker to close a position when the price reaches a certain preset level. It is the exact opposite of a stop-loss order. A take profit option is provided in almost all major trading platforms like MetaTrader 4 and 5.
How a take profit order works
A take profit order is a relatively easy-to-understand order type. For example, if a company’s share price is trading at $20 and you believe that it will rise to $30, you can place a buy order.
This means that you will profit when the price moves above $20. You can then set a take-profit at $30, meaning that the broker will close the order automatically when it reaches that level.
For the same trade, you can add a stop loss at $15.
How to use a T/P order well
In addition to capturing profits, some day traders use take profit orders in more ways. For example, there are some who use these orders to initiate other limit orders. If the stock is trading at $20, you can place a take profit order at $25. This will automatically close the position when it reaches this level. At the same time, you can place other limit orders close to this position.
For example, if you expect the asset’s price to drop sharply after reaching $25, you can place a sell-limit order at $23. The idea is that if the price drops, the bearish pattern will be confirmed if it reaches $23.
At the same time, you can also place a buy stop order at $27. The idea is that if the price fails to stop at $25, bulls will then start targeting $30. And this order will be confirmed if it reaches $27.
These order types are used by all types of traders. However, those who mostly benefit from them are people who trade part-time. For example, if you have a 9 to 5 job, you can easily set up these orders and go to work. They will be initiated when you are not there.
» Benefits of Partial Profit Taking
How to set a take profit order?
A common question among traders is on the best places to place a take profit order. While there is no written rule about this, many traders use several approaches to this.
Use your risk-reward ratio
One of the best approaches is to use your risk-reward ratio to set your take profit. For example, if you only risk 5% of your cash, you can set your TP 5% above the current price. In this case, if the stock is trading at $20, you could place it at $21.
This might be a small level, but keep in mind that it is a 5% return on your trade.
Levels of Fibonacci Retracement
Another approach is to use the Fibonacci retracement levels. If a price is trading at $20, which is the 23.6% retracement level, you can add a take profit at the 38.2% level at $24. Ideally, in most cases, when a price moves above the 23.6% retracement, there is a higher chance that it will test the 38.6% level. Therefore, you can set the take profit there.
Psychological levels
Further, you can use the key psychological level. For example, if the price of crude oil is trading at $63 and it manages to go above $65, the next logical level of resistance will be at $70. Round numbers are important levels because that’s where most day traders place their take profits and stop losses.
Summary
Take profit orders are important in the financial market because they help you to manage your risk. They also help you to set up your trades when you have a busy schedule. If you are new to trading, we recommend that you take time to learn about these orders and experiment with them.
A demo account, which is a free account that is provided by most trading platforms can help you with this.
External useful resources
- How to Use a Stop-Loss and a Take-Profit in Forex Trading – Admiralmarkets
