Profit-Taking

What Is Profit-Taking?

Profit-taking is the act of selling a security to lock in gains after it has risen appreciably. While the process benefits the investor taking the profits, it can hurt other investors by sending shares of their investment lower, without notice.

Profit-taking can affect an individual stock, a specific sector, or the broad financial market. Assuming there is an unexpected decline in a stock or equity index that has been rising, with no information or external events to support a selloff, it might be attributed to numerous investors taking profits.

Understanding Profit Taking

While profit-taking can affect any security that has advanced (e.g., stocks, bonds, mutual funds, or potentially exchange-traded funds), people utilize the term most normally in relation to stocks and equity indices.

A specific catalyst often triggers profit-taking, for example, a stock moving over a specific price target; be that as it may, profit-taking may likewise happen simply in light of the fact that the price of a security has risen sharply in a short period of time.

A catalyst that frequently triggers profit-taking in a stock is the quarterly or annual earnings report (SEC Forms 10-Q or 10-K, respectively). This is one justification for why a stock might be more volatile in the weeks encompassing the period when it reports results.

On the off chance that a stock has acquired significantly, traders and investors might take profits even before the company reports earnings to lock in gains, rather than risk profits dissipating, in the event that the earnings report disappoints. Investors may likewise take profits after earnings are reported to prevent further declines (e.g., in the event that the company has missed expectations on earnings per share (EPS), revenue growth, margins, or guidance).

A take-profit order (T/P) is a type of limit order that specifies the exact price at which to close out an open position for a profit. On the off chance that the price of the security doesn't arrive at the limit price, the take-profit order doesn't get filled.

Types of Taking Profits

Taking Profits in a Specific Sector

Profit-taking in a specific sector — even against the backdrop of a strong bull market — could be triggered by an event specific to that sector. For example, a bellwether stock could report unexpectedly weak earnings in an otherwise hot sector, which could subsequently trigger profit-taking across the entire sector as a result of fear. In the event that a promising tech company had a poor initial public offering (IPO), investors might be keen to exit the sector overall.

Assuming that the profit taking is one-time event-driven —, for example, in response to a profit report — the overall direction of the stock is unlikely to change long-term, but if the profit-taking is in response to a greater issue (like stresses over economic policy or other macro issues) longer-term stock weakness could be a risk.

Broad Market Profit-Taking

Profit-taking in the broad market is generally a result of economic data, for example, a weak U.S. payrolls number or a macroeconomic concern (like concerns over high levels of debt or currency turmoil). In addition, systematic profit-taking could happen due to geopolitical reasons, like war or acts of terrorism.

It is important to note that profit-taking is typically a short-term phenomenon. The stock or equity index might resume its advance once profit-taking has run its course. Yet a concerted bout of profit-taking that knocks a stock or index down by several percentage points could signal a fundamental change in investor sentiment and portend additional declines to come.

Highlights

• With profit-taking, an investor trades out certain gains out a security that has revitalized since the time of purchase.
• Profit-taking benefits the investor taking the profits, but it can hurt an investor who doesn't sell since it pushes the price of the stock lower (at least in the short term).
• Profit-taking can likewise hit a broad sector or the overall market; in this case, it might be triggered by a greater event, like a positive economic report or a change in Federal Reserve monetary policy.
• Profit-taking can be triggered by a stock-specific catalyst, for example, a better-than-expected quarterly report or an analyst upgrade.