Introduction
A take-profit order, also known as a limit-closing order, is a type of limit order with a fixed price. After that, your trading service will close your open position for a profit at this price. If the limit order doesn't reach the limit price, it remains inactive.
Take-profit orders are crucial tools for traders looking to lock in their profits at a predetermined price level. By setting a take-profit order, traders can ensure that their positions are closed at a favourable price, reducing the risk of losing gains due to market fluctuations.
What is a take-profit order?
A take-profit (TP) trading order directs a broker to terminate a trade as soon as the market hits a predetermined profit threshold. With this type of order, traders can automatically secure their profits without constantly monitoring their open positions.
Take-profit orders frequently work in tandem with stop-loss orders to control risk and protect potential earnings.
Traders also use take-profit and stop-loss orders in tandem to reduce the risk associated with open positions. If you decide to go long when an asset reaches the take-profit level, we immediately fill the order and close the position profitably. If the asset falls instead, we will execute the stop-loss order to reduce losses at a level suitable for your risk tolerance.
Therefore, the difference between the asset's market price and your take-profit and stop-loss orders represents the maximum risk-reward trade-off for this transaction.
Let's say a trader initiates a long position in an asset with the expectation that it will increase by 20%. A take-profit order placed 20% above the bought-at price and a stop-loss purchase placed 5% below the bought-in price are possible. If the odds of each scenario are equal or slanted upward, this results in a favourable 5:20 risk-to-reward ratio.
What is a stop-loss order?
To fully understand what a take-profit order is in forex, you should also understand what a stop-loss order is.
Traders use a stop-loss order, often referred to as a stop-closing order, to lock in the remaining profit on an open position or to restrict loss. It's an essential instrument for trade risk management.
When an asset hits your target price, stop-loss orders advise you to liquidate your position by either purchasing or selling it at the market, depending on whether you are long or short. We call this the stop price.
Assume that our trader purchases a stock option and sets a stop-loss order at a price 5% below the purchase. When the stock drops by 5%, the trader activates the stop-loss, enabling the sale of the stock at the optimal price. If the trader had instead chosen to short the stock, the position would have closed when the asset started to trade at the predetermined price through an offset purchase.
How does take-profit orders work?
When a trader files a take-profit order, the broker will close the deal if the market price hits the designated take-profit level.
For short positions, we place the take-profit order below the entry price, and for long positions, we place it above the entrance price. Once we reach a certain level, we guarantee a specific profit, even though it halts any additional profit growth. Take-profit orders are a good way to lock up earnings.
For example, if you are long USD/CAD at 120.50 and want to collect your profit when the rate hits 121.00, you would designate this rate as your take-profit level.
When the bid price hits 121.00, the open position automatically closes, securing your profit.
In a market that moves quickly, there can be a discrepancy between the closing market rate and the take-profit rate you have established.
The order will stay pending until the trader cancels it or the position is cancelled for another reason if the market price never hits the take-profit threshold.
How to place take profit and stop loss levels?
Determining the most effective levels for take-profit (TP) and stop-loss (SL) orders can be quite a complex task in the world of trading. Usually, establishing a stop-loss is considered a simpler task, whereas deciding on the appropriate level for a take-profit order can be discretionary and sometimes not required.
For example, when following market trends, accurately predicting the future strength of a trend can be quite challenging. Traders, in such situations, enter the market, set a stop loss to handle potential losses, and ride the trend for as long as its momentum continues. On the other hand, some traders use take-profit orders as a proactive strategy in their trading approach.
As mentioned SL and PT placements are largely dependent on your trading strategy. Each trading strategy has different tools and approaches to market analysis, let’s look at some of the popular ones:
Trendlines
Trendlines are crucial for establishing stop loss and take profit targets. Traders strategically place trendlines at the peaks of price swings to gain a clearer understanding of potential price ranges. SL and TP orders are strategically placed below or above the trendlines, taking into account the price direction.
Traders often employ multiple-time frame analysis to strategically determine the optimal placement of stop-loss (SL) and take-profit (TP) levels. By conducting thorough analysis, traders can effectively steer clear of opening trades that carry a high level of risk. We achieve this by identifying and considering significant levels in the market.
Support and resistance levels
Traders carefully study charts to identify areas where prices may encounter resistance or find support, allowing them to anticipate possible reversals in price. When a price approaches a certain level and fails to break through, it is considered a significant level. This level can be seen as either support or resistance, depending on the direction of the price movement.
Fundamental factors
Economic and political events have the potential to cause significant price fluctuations in the market, which can then activate stop-loss orders. This is why many traders closely monitor the economic calendar and stay informed about political developments to avoid placing orders before or during these events.
Fibonacci retracement
Traders often utilise Fibonacci retracement as a valuable tool for identifying potential price reversal points. Traders often rely on Fibonacci numbers to determine the ideal levels for setting SL and TP orders.
Placing SL and TP varies according to the circumstances, but the general objective is to do so in a way that maximises profits and minimises losses.
Reducing SL and TP orders with accuracy calls for a level of ability that sets seasoned traders apart. Rather than being a haphazard choice, this should ideally be a deliberate activity made within the parameters of a clearly defined trading strategy.
One well-known strategy that aids traders in avoiding emotional swings is setting SL and TP levels and never changing them once in a trade.
On the other hand, some traders choose a more active strategy, moving the stop loss into a lucrative position when the price moves rapidly in their favour. This strategy preserves gains while taking advantage of beneficial market developments.
There are several benefits to using both trading tactics, especially when combined. Combining multiple orders reduces the overall risk associated with a trade, which is the main benefit. But there are some drawbacks, just like with any trading strategy.
Pros and cons of take-profit orders
Pros
Technical analysis tools, like money management systems or chart patterns, allow take-profit orders to be set at levels that are supported.
Traders have the ability to automatically lock in their profits, enabling them to profit from favourable market conditions without having to constantly check on their positions.
It is not necessary for traders to monitor their trades throughout the day or worry about the potential peak or low of an asset. This keeps emotions out of the transaction.
Traders can efficiently control their risk and shield their money from erratic market swings by establishing predetermined exit points.
Cons
Although trade automation can be a very useful tool for risk management, it can also lead to laziness among traders, which increases the likelihood of errors.
A trader’s flexibility may be restricted by setting a predetermined take profit level, since it may lead to an early closure of the position should the market continue to move in the trader’s favour.
Take-profit orders are executed at the predetermined price, independent of the performance of the asset. Opportunity costs will arise since the order will still be executed even if it begins to break out higher.
Using take-profit orders can help long-term investors lower their risk, but it also lowers their potential returns.
Take profit orders are susceptible to slippage, which happens when an order is executed at a price lower than the planned price, just like any other sort of trade. Take-profit orders may be less effective overall if there is slippage, especially when volatility is strong.
Conclusion
To sum up, take-profit orders enable traders to automatically lock in their profits, which aids in risk management and emotional self-control when executing trading methods. Traders can take advantage of favourable market conditions and protect their investments by establishing pre-established exit points.
Take-profit orders can have several potential disadvantages, though, including less flexibility, lost opportunities, and a higher risk of slippage. To reduce these risks, you should carefully examine market conditions, modify their take profit levels as necessary, and, when appropriate, think about employing different order types.
