What Is Profit-Taking?
Profit-taking is selling a security to lock in gains after it has risen appreciably. Profit-taking can affect an individual stock, a specific sector, or the broad financial market.
A profit-taking event may lead to an unexpected decline in a stock price or equity index. External forces such as company news or market data may trigger profit-taking.
Key Takeaways
- With profit-taking, an investor cashes out gains in a security that has rallied since the time of purchase.
- Profit-taking benefits the investor taking the profits, but often pushes the stock price lower in the short term.
- Profit-taking can be triggered by a better-than-expected quarterly report or analyst upgrade.
Selling Triggers
Profit-taking can affect any advancing investment, such as stocks, bonds, mutual funds, or exchange-traded funds (ETFs). A specific catalyst often triggers profit-taking, such as a stock moving above a price target; however, profit-taking may also occur simply because the price of a security has risen sharply in a short period.
The quarterly or annual earnings report like SEC Forms 10-Q or 10-K triggers profit-taking in a stock. A stock may be more volatile in the weeks surrounding the period when the company reports results. Traders may take profits even before the company reports earnings to lock in gains, rather than risk profits dissipating if the earnings report disappoints.
Investors may also take profits after earnings are reported to prevent further declines if the company has missed expectations on earnings per share (EPS), revenue growth, margins, or guidance.
A take-profit order (T/P) is alimit orderspecifying the exact price to close out an open position for a profit.If the price does not reach the limit price, the order will not be filled.
Sector vs. Broad Market
Profit-taking in a specific sector—even against 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 may trigger profit-taking across the entire sector. A promising tech company with a poor initial public offering (IPO) may drive investors to exit the sector.
Profit-taking in the broad market is usually a result of economic data, such as a weak U.S. payroll number, high levels of debt, or currency turmoil. In addition, systematic profit-taking could occur due to geopolitical reasons, such as war or acts of terrorism.
How Does an IPO Affect Profit Taking?
When a company begins trading with a potentiallyhot IPO, the share price can spike during the first trading day but fall rapidly. This commonly occurs due to the large number of market orders at the open, followed byprofit-takingby buyers who have their trades filled early and then profit from the run-up in price.
How Long Does a Period of Profit Taking Last?
Profit-taking is typically a short-term phenomenon. The stock or equity index may resume its advance once profit-taking has run its course. However, a concerted effort 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.
How Does Profit Taking Affect a Stock's Long Term Price?
If the profit-taking is one-time event-driven—such as in response to an earnings report—the overall direction of the stock is unlikely to change long-term. If the profit-taking is driven by a bigger issue such as economic policy, long-term stock price weakness may occur.
The Bottom Line
When an investor sells a security that has increased in value since its purchase, it's called profit-taking. Profit-taking events may push the stock price lower in the short term. Profit-taking can be triggered by a company's quarterly or annual report, an analyst upgrade, or a macroeconomic event.
