What is a Profit Target?
A profit target is a predetermined point at which an investor will exit a trade in a profitable position. Profit targets are part of many trading strategies that investors and technical traders use to manage risk.
- Profit targets can help an investor reduce risk by creating a target price where the trader wants to take a profit on a trade.
- Profit targets can be set up at the onset of a new trade and help a trader reduce portfolio volatility.
Understanding a Profit Target
Profit targets can be determined at various points of an investment. Investors can initiate conditional orders to achieve their profit target. Some trading strategies integrate a profit target with an initial order.
In other cases an investor might use a conditional order to set a profit target after identifying certain forward looking projections. Profit targets can be popular as many traders/investors like to have a game plan at the onset of placing a trade, or when new information on an investment occurs.
Profit targets can be a good way to manage the risk of high risk investments. Often, high risk investments require regular due diligence. Thus, identifying and following a profit target strategy can help an investor to cash in on profits and mitigate any potential for losses.
Many covered investment strategies use two legged positions which integrate a planned entrance and exit strategy for an investment with a specified level of profit. Covered strategies are commonly used when futures and options trading is involved. There are several scenarios where an investor can enter into an investment position with a guaranteed profit target. A calendar spread futures trade is one example.
In this trade, an investor seeks to identify a commodity selling at a lower price than its corresponding futures contract at some time in the future. Entering into both the long position and the short futures contract position provides for a guaranteed profit that can be seen as a profit target.
Trading strategies can also include bracketed conditional orders that can provide an investor with a profit target as well as maximum loss constraint. A bracketed buy order is one example of this type of trade. In a bracketed buy order, an investor places a conditional order to buy at a specified price. Along with the order they also place a stop loss condition as well as a profit limit condition. After buying the security, the stop loss and profit constraint provide for an integrated profit target and maximum loss.
In a more simplified approach to profit target investing, an investor may choose to use a standard profit limit order to manage towards a specified profit target. A profit limit order is a sell order usually programmed as a good until canceled order (GTC). This conditional order is scheduled to sell a security at a price higher than its current trading price. Investors may use this type of order when investing in a cyclical security. Many traders may also choose to set conditional profit limit orders at a stock’s peak resistance level.
The opposite of a profit target is a stop loss. A stop loss order sets a price point at which an investor exits a trade that has experienced a predetermined level of loss in order to avoid losing even more.