Taking profits is extremely important when trading. After all, you only make money when you actually close the position and take money off the table, explains Markus Heitkoetter of Rockwell Trading.
The key question is: When exactly do you take profits? Most traders take profits either too early and leave money on the table. Or they take profits too late—after a stock has already made a high and is now turning around. In this article, I will show you my favorite profit-taking strategy for stock market trading.
What Is a Profit-Taking Strategy?
A profit-taking strategy defines when exactly you sell your stock (or option) to realize a profit. Many traders don’t have a profit-taking strategy in place when trading. Often they say: “I’ll sell the stock when I've made enough money.” The problem: There’s never “enough money.”
Often traders are too greedy and expect ONE stock to make up for all the money they lost in the past. That’s why they hold onto a stock for too long. These days, trends are short-lived, and markets can turn around on a dime. If you don’t have a solid profit-taking strategy for your trading, you could end up leaving a lot of money on the table!
How Do You Create an Exit Strategy?
I personally like to keep it simple. Here’s a simple, yet powerful, profit-taking strategy: P = 2 x R
This means: Take profits when you make twice as much money as you risk. Here’s an example: I highly recommend using the 2% rule for your risk, i.e., you should never risk more than 2% of your trading account on any given trade. So. if you have a $10,000 account, don’t risk more than 2% = $200. When you risk $200, you should take profits as soon as you make $400. With a simple profit-taking strategy like that, you will make money even if you’re wrong half of the time.
Advanced Profit-Taking Strategies
Here’s the challenge...when you're using the simple profit-taking strategy that I outlined above, you might leave some profits on the table. Because when a stock is more volatile, you could get 3 x R, or maybe even more. As an example, when you look at the stock SLCA, you could easily get 5 x R, i.e., you could get $1,000 for every $200 that you risk. In this case, what do you do? Do you try to get 5 x R, even though it is more aggressive? Or do you stick with the more conservative 2 x R?
Is There a Best Way to Exit a Trade?
Here’s what I personally like to do. I like to use the best of both worlds. I take profits for 1/2 of my position when I see 2 X R, and then I take the remainder of the profits when the stock gets to my optimized profit target, i.e., 5 x R.
Here’s an example:
Let’s say you’re trading 100 shares of ABC. Your risk is $2 per share, i.e. $200 for 100 shares. Your conservative profit target is 2 X R = 2 x $2 = $4. Your optimized profit target is 5 X R = 5 x $2 = $10.
I personally sell 50 of the 100 shares as soon as I can get $4 in profits per share. In this case, I would make 50 x $4 = $200. Now I cut the stop loss for the remaining 50 shares in half. Instead of risking $2 per share, I will now risk only $1 per share. Since I have 50 shares left, my risk is now reduced from $200 to $50. But the best: since I already sold half of my shares, I already made $200.
This money has been deposited into my account. So, if the stock turns around now and I get stopped out, I only give back $50 of these $200. Therefore, my total profit for this trade would be $150.
As you can see, once I take profits, I cannot lose on this trade anymore—even if the stock turns around. And if it keeps going up, I can sell the remaining 50 shares when the stock moves up $10, which is my optimized target. In this case, I would realize an additional $500 for a total of $700.
3 Different Profit-Taking Strategies
Let’s recap:
- Conservative Profit Taking Strategy:
In this case, you would risk $200 to make $400. Not bad. - Optimized Profit Taking Strategy:
In this case, you would risk $200 to make $1,000. Sounds better, but it’s less likely. The stock might turn around and you get stopped out before the stock reaches this aggressive target. - My “Best of Both Worlds” Profit-Taking Strategy:
In this case, you would risk $200, and as soon as the stock moves up by $4, you take profits for half of your position. Now you can’t lose anymore and have a “free trade” that hopefully achieves your optimized profit target.
I can relax, sit back, and don’t have to worry about this trade anymore. If everything works out, I’m making $700 on this trade. If it doesn’t work out, I still make $150.
Important!
This example is for an account of $10,000, and if you get the $700 in profits, you make 7%—on one trade! That’s pretty good! As you can see, THIS is smart trade management.
Learn more about Markus Heitkoetter at Rockwell Trading.
