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February 5, 2010
Profit Taking

Generalized profit taking temporarily depresses a stock price during an upward stock trend. Traders and investors take profits in order to lock in gains on an advancing stock. A famous old saying is that you don’t have a profit on a stock until you take a profit. The temporary drop in stock price from profit taking is different from a correction in which the market analysis of a stock changes, driving the price down. In fact, investors and traders often take profits when they anticipate a correction.

Taking short term profits is the heart of day trading. The point for the day trader is to buy stock and sell stock during market fluctuations throughout the day. Someone who only does long term investing will typically only engage in profit taking after a substantial run up in a stock price and when he or she believes that the stock is ready for a large correction. Long term investors will usually stay invested during swings in stock price caused by profit taking. In value investing the investor will take their profits and get out of a stock position when the stock has increased in price to where it represents normal value and not a buying opportunity.

Profit taking usually occurs after rapid advances in stock prices. The thinking is usually that the market has gotten ahead of itself and will correct. Thus many wise traders and investors “take a little off the table.” This is one of the simple stop loss strategies that help reduce investment risk. When a stock drops back with profit taking and then advances again it’s often an indication the stock is going to continue its advance.

One of the basics of stock market investing is to know how to set reasonable goals for investing in stock. There are many investors that will set a goal, based upon market analysis, of how much gain to reasonably expect from a stock before periodic profit taking turns into a substantial correction. Getting greedy and trying to milk the last two of three percent profit out of a stock too often results in the investor losing much if not most of his or her gains.

The same applies in day trading. Setting reasonable limits, getting out of a position bit by bit and taking profit may seem to be giving away profits but, over the long term, this sort of sound trading strategy is more profitable.

Many investors get irritated at the dip in a stock price as investors take profits as it, temporarily, reduces the value of their stock shares. However, this is part of what makes the stock market work. The long term value of a stock has to do with the success and prospects of the company’s business. However, no matter how attractive a company is, its stock needs to compete with others for buyers. If other opportunities arise in other market sectors, a company’s stock price may correct. Traders may take profits from a successful stock and put their money in alternative investments. It is all part of a fluid and open market which, in the end, provides the investor with the best set of investing opportunities.

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