Take-Profit

A Take-Profit order (often abbreviated as T/P) is a pre-set instruction given to your brokerage to automatically close a profitable position once the price of an asset reaches a specific, predetermined level. Think of it as an automated exit strategy for your winners. It’s a type of limit order that ensures you lock in profits without having to manually monitor the market tick-by-tick. For instance, if you buy a stock at $50 and believe it will rise, you might place a take-profit order at $65. If and when the stock's price hits $65, your broker automatically executes a sell order, converting your paper profit into real cash in your account. This tool is designed to impose discipline and take the emotion of greed out of the equation, preventing you from holding on too long in the hope of even greater gains, only to see the price fall back down.

The mechanics are wonderfully simple. When you open a position (either buying a stock or even short selling one), you can simultaneously place a corresponding take-profit order.

• For a long position (you own the stock): You set a take-profit price above your purchase price. When the market price hits your target, it triggers a sell order.
• For a short position (you've borrowed and sold a stock): You set a take-profit price below your entry price. When the market price drops to your target, it triggers a buy-to-cover order, closing your position for a profit.

The order remains dormant until your price target is met. It's a “set it and forget it” tool that executes automatically, whether you're at your desk, on vacation, or fast asleep. It removes the temptation to second-guess your own strategy in the heat of the moment.

For a dictionary rooted in value investing, the take-profit order is a fascinating and somewhat controversial tool. While traders love it, the dedicated value investor approaches it with a healthy dose of skepticism.

The primary benefit of a take-profit order is that it enforces discipline. Greed is a powerful emotion that can convince an investor to hold a winning stock well past its reasonable valuation, hoping to squeeze out every last drop of profit. A take-profit order acts as a circuit breaker against this impulse, ensuring you stick to your original price target. It can be particularly useful in managing positions in highly volatile sectors where prices can swing dramatically in a short period.

Here's the rub: value investing is about buying wonderful businesses at fair prices, not just watching price tickers. The decision to sell should be based on fundamental analysis, not an arbitrary price point. A true value investor typically sells for one of three reasons:

1. The stock has become significantly overvalued, far exceeding its calculated intrinsic value.
2. The underlying fundamentals of the business have deteriorated.
3. A far more compelling investment opportunity has emerged, offering a better return with a wider margin of safety.

A rigid take-profit order ignores all of this crucial context. It treats the stock as a number on a screen rather than a piece of a living, breathing business. Selling a fantastic company simply because its stock price increased 20% might mean missing out on the next 200% of growth if the business continues to excel. As Warren Buffett famously said, “Our favorite holding period is forever.”

So, is it useless? Not entirely. While a strict, automated take-profit order is more at home in the world of technical analysis and short-term trading, the principle is sound. A value investor should absolutely have a “take-profit plan.” This involves calculating a company's intrinsic value and deciding at what level of overvaluation you would be prompted to re-evaluate and likely sell. The key difference is that this is a trigger for a thoughtful review, not an automatic, emotionless sale. It’s about having a sell discipline, not a sell dogma.

It's easy to confuse take-profit orders with their risk-management sibling, the stop-loss order. While they are both pre-set orders that close a position, they serve opposite functions.

• Purpose: A take-profit order is used to secure profits. A stop-loss order is used to limit losses.
• Emotion: Take-profit battles greed. Stop-loss battles fear and the false hope that a losing stock will rebound.
• Placement (for a long position): A take-profit order is placed above the current market price. A stop-loss order is placed below the current market price.

Together, they form a bracket around your trade, defining the potential upside you're targeting and the maximum downside you're willing to tolerate.

Let's say you've done your homework on “Innovate Corp.” (ticker: INVT) and bought 100 shares at €80 per share. Your analysis suggests its intrinsic value is around €110, but you want to ensure you capture a solid gain if the market has a sudden burst of enthusiasm. You decide to place a take-profit order at €105. You enter this order with your broker. Weeks later, good news sends INVT soaring. As soon as the stock trades at €105, your take-profit order is triggered, and your 100 shares are automatically sold. You have locked in a profit of (€105 - €80) x 100 = €2,500, minus any commissions. You didn't have to lift a finger, and you weren't tempted to hold on for €106, only to see it potentially fall back to €90 the next day.