Profit Taking

DEFINITION of 'Profit Taking'

The act of selling a security in order to lock in gains after it has risen appreciably. Profit taking can affect an individual stock, a specific sector, or the broad market. If there is an unexpected decline in a stock or equity index that has been rising, and no specific reason for the drop can be identified, the decline is frequently attributed to profit taking.

BREAKING DOWN 'Profit Taking'

While profit taking can affect any security that has advanced – stocks, bonds, mutual funds, exchange-traded funds – the term is most commonly used in relation to stocks and equity indices.

Profit taking is often triggered by a specific catalyst, but it may sometimes occur simply because a security has risen sharply in a short period of time. A catalyst that frequently triggers profit taking in a stock is the quarterly earnings report, which is one reason why a stock may be more volatile around the time it reports earnings.

If a stock has gained significantly, traders and investors may take profits in it even before earnings are reported, so as to lock in gains rather than risk these profits dissipating if the earnings report disappoints. Profit taking may also be achieved after earnings are reported, like if the company has missed expectations on any front – EPS, revenue growth, margins, guidance etc.

Profit taking in a specific sector – even against the backdrop of a strong bull market – could be triggered by a development or event that is specific to that sector. For example, an unexpectedly weak earnings report by a bellwether company in a hot sector could trigger profit taking across the entire sector.

Profit taking in the broad market is usually caused by economic data – such as a weak U.S. payrolls number – or a macroeconomic (debt concerns, currency turmoil) or geopolitical (war, act of terrorism) event.

Note that profit taking is typically a short-term phenomenon, and the stock or equity index may resume its advance once profit taking has run its course. But a concerted bout of profit taking that knocks a stock or index down by several percentage points could signal a change in sentiment, and portend additional declines to come.