Profit Taking

Updated on April 12, 2024
Article byVishal Garg
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Profit Taking Definition

Profit-taking is used when the investors sell their assets, mainly shares, and securities, to the market when the price has risen. It can harm the investors who are not selling shares when the prices rise. The aggressive investors wait for the desired percentage hike in the prices of the shares, and then he opts to sell the shares or securities in the market.

Profit Taking Definition

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The activities involved in trading the shares and securities are different for different company stocks; the investors should carefully invest their money in the share market as it is a speculative market. Those short-lived investors can opt for the profit-taking strategy to earn some assured profits with lesser risk when they involve their monies in the market for a longer period.

Key Takeaways

  • Profit-taking involves selling assets, such as shares and securities, in the market at higher prices. Holding onto appreciating assets can lead to missed opportunities. 
  • Active investors keenly monitor price movements and may execute sales when achieving a desired percentage gain.
  • Personalized strategies are paramount in stock and share trading. The primary goal is to sell assets strategically, aiming to capitalize on optimal market conditions that boost profitability. Successful trading hinges on mastering when to execute these well-timed sales.
  • Timing is key. Consider selling stocks after a 20-25% price increase, ensuring gains are secured. 

Profit Taking Explained

Profit-taking is a step toward earning the desired profit from the shares or securities the investors buy at some point. The investors wait for the hike in the stock price or shares and when it will be beneficial for them to sell that to take the profits from the same. This can negatively affect investors who are not aggressive in their investments. It can create discontent among other unaware investors who fail to sell their stocks or shares when the price rises. It should always be noted that it is a temporary solution for investors who want to gain from the stock’s sale and that it can be sold out quickly. The investors could have kept the stocks profit taking or shares for extended periods before selling. Still, the investors who want to convert the shares into liquid cash with some profit element also have to opt for such a phenomenon.

Profit Taking

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Strategy

The best profit taking strategy can be different for different stocks or shares. Every strategy made and followed should be different from each other. In general, this strategy should know when to sell the shares or stocks in the market to earn maximum profits. Most investors who are not aggressive don’t have any strategy to be followed to take the profits, but some investors define the strategy which helps them earn maximum profits.

Nowadays, traditional investors are also moving towards a short-lived strategy in the share market. They buy the shares when the prices are low, study the trend of that security, and then sell the shares of stock in the market when the price rises. These types of investors earn short-term profits.

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How To Take Profit From Trading?

Many strategies are made and followed by investors who are very active in trading. They already set their targets of the desired stocks profit taking when they opt to buy the stocks or shares of the company. It is a belief that the investors can make small profits if they continue to take the profits for the shares regularly rather than waiting for the harvesting time for the shares when they can achieve great returns. Although it is advisable to wait for the returns, the investors are nowadays short-lived in the market, and hence they take profits from the shares very early.

The trading in shares or taking profit in crypto is also a king gambling game when the prices may go up or down without any notice to the investors, and hence it can be a good idea to derive profits at the early stage if it is beneficial to do so. Investors should take a step forward in understanding the stock movement, which can affect their share prices; by following this, they can achieve the desired profits from trading the shares or stocks.

Examples

Let us take the example of Mike, who is has purchased 100 units of the stock of a particular company at $100 each. It is a growing company with good future potential. Mike expects a return of about 25% from the stock, which is $125. So, he plans to sell it when the price rises to $125. After a month, the stock shows rise in price and as soon as it reaches the expected price, he sells it, thus taking a profit of $25 on 100 stocks, that is $2500. So, we see that Mike books a profit of 25% on his holding within one month.

Rules

There are certain rules for best profit taking strategy that are followed in the process, without which it will not be possible to book the profits on time.  

  • The investors are advised to understand the market and the price movement of the shares in the market. The basic rule is to get a 20% to 25% hike in the prices, and then the investors are advised to sell the stocks or shares; if the prices are not hiked with the desired percentage, the investors should not sell the stock but should wait for some time to get the maximum returns or profits. Without proper understanding and knowledge of how to interpret the technical charts, what is the meaning of certain management decision taken by the company or what is the real reason behind the sudden price movement, it is not possible to implement the concept.
  • The profit percentage is fixed as per the expectation of the trader or investor from the market. If the stock is a good company with high growth opportunity and good future potential, the trader may expect a high return.
  • For stocks or options profit-taking strategy, monitoring the stock or financial instrument from which the profit is expected is necessary. If the investor does not track the news, market movements, company performance, etc., they may miss the price rise and fail to book the profits.
  • Trailing stop-loss order is a tool in this concept, in which the order is placed below the current market price and adjust upwards as the price rises. The stock sells off automatically is the price falls below a particular level, allowing the investor to earn profit.

These rules mentioned above help investors who trade to understand which is the exact time or level of price that will help them to take the profit for the securities that they are currently holding.

Benefits

Some benefits of the concept are as follows:

  • When an investor opts for this strategy, it can get quick and desired profits in a short period.
  • Risk is lower in this technique because the liquid cash is achieved out of the shares in the planned time.
  • Some investors can do market research and then buy back those shares in the future since they are now aware of the trend of the price movements of those company shares.
  • Short-lived investors can easily enter and exit the stock market, and they will get themselves risk-free by encashing the shares before the time to get rid of the market fluctuations.
  • Shares and stock markets are speculative; therefore, it is a great opportunity for investors to take their profits when the prices are high of particular shares.
  • The trading planning to minimize the risk of loss from the shares will increase the investors to take the profit after achieving a certain percentage.

Thus, these are some of the benefits in the case of both stocks or options profit taking strategy.

Limitations

It is necessary to look at the limitations also in order to understand it better.

  • This mechanism hurts the sentiments of investors who fail to make a profit when their share price has risen.
  • Profit-taking discourages investors who can invest in the shares in the long term.
  • This method always encourages investors to profit within a short period; be it stocks or taking profit in crypto, traditional investors are ready to keep their money in the market for a more extended period to earn more returns.
  • The share market speculation may give huge returns to the investors only if they wait for the harvest time of their shares, but the investors who follow the profit-taking are not interested in doing so.

Frequently Asked Questions (FAQs)

1. What is the importance of a profit-taking strategy?

A profit-taking strategy is crucial for investors to secure gains and manage risk. It helps prevent overexposure to market fluctuations and lock in profits opportunistically. By systematically selling a portion of profitable positions, investors can rebalance their portfolios, reduce potential losses during market downturns, and ensure that gains are realized and preserved.

2. What are the risks associated with the profit-taking strategy?

While profit-taking mitigates risk, it can also expose investors to certain drawbacks. Premature profit-taking might result in missing out on potential future gains if assets continue to appreciate. Overly frequent trading to capture profits can lead to transaction costs, taxes, and reduced long-term returns. Moreover, miscalculating when to take profits could result in selling winners too soon or holding onto losers for too long.

3. How does the profit-taking strategy impact market volatility?

Profit-taking strategies can influence market volatility to some extent. When a significant number of investors decide to sell and take profits simultaneously, it can lead to short-term price fluctuations and heightened market volatility. However, the broader market forces and factors also play a substantial role in determining overall volatility. Profit-taking, if done on a large scale, might contribute to short-term fluctuations, but its impact on sustained market volatility is limited.

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