What Is a Profit Target?
A profit target is a predetermined price point at which an investor will exit a trade for a positive gain. Profit targets are part of many trading strategies that investors and technical traders use to manage risk, and the target can be set using one of many techniques or criteria.
- A profit target is a price level set at the initiation of a trade at which point the trader will exit for a gain.
- 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 Profit Targets
Profit targets can be determined and re-evaluated at various points during the holding period of an investment. An initial profit target can be made when a trade is first established, using techniques that range from technical positions on a chart, fundamental analysis of a company's financials, or a heuristic such as after 10% or a certain dollar point increase.
An investor might use a conditional order (e.g., a limit 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 typically programmed as a good until canceled order (GTC). This conditional order is scheduled to close out a position at a predetermined price for a profit. 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.
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