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A take profit order is a limit placed on a trade, clearly specifying the exact rate from the entry point. Placing a take profit order ensures that the trader can lock his profit and close the trade.
The main reason why take profit order is placed by traders is because they do not know how far the market will go. No trader can expect or is always completely right about his forecast of the market. Therefore, they use the charts at their disposal to understand the resistance levels. If they find that a trade is showing resistance at a particular level, they will place a take profit order at that point so that they can exit with the profits earned.
Take profit order is opposite to a stop loss order. In a stop loss order, you place a limit on the loss and exit. But in a take profit order, you place a cap on the profit and exit when you are ahead.
This is where understanding how to read charts comes into use. When you check the charts and find that the trend of the market is long term, there is no use of a take profit order, as the trend is likely to continue. The trader can continue to earn profits by going with the trend. However, when the market is going against you, or against the trend, it is essential to place a take profit order. The trend will prevail and it is better to take your profits after reaching a certain expected level and exiting.
For example, when you buying yen worth $100 at a price of 107 yen per dollar, and place a take profit order at 108, the currency will be automatically closed when the price reaches 108. Therefore, your initial investment was 107,00 and sale was at 10800. You make a profit of 100 yen.
Take profit orders are of two types as given below
Manual take profit orders
In this type of order, you need the discipline to close the trade when it reaches the expected value. Procrastinating can lead to losses and on the other hand, the price may also rise up higher. The trade is closed manually.
Automatic Take profit order
In this type of order, a cap is placed and the trade is closed automatically when it reaches the pre-specified point.
It is true that placing a take profit order limits the profits on the trade but it is equally true that it protects the trader against a sudden reversal of the market. Unlike stop loss orders, they should be used occasionally when quick profits are needed and exit the market.
