Profit taking definition
/What is Profit Taking?
Profit taking involves the sale of an asset after its value has risen higher than the original purchase price. By selling at this point, the owner realizes a profit on the sale. The term is most commonly applied to the sale of securities, where the profit taking event is triggered by the security price having risen sufficiently above the original purchase price and any sale transaction costs to generate a reasonable profit. Alternatively, profit taking may be triggered when there is an expectation that the security price is now maximized, and may begin to decline. For example, a company issues a relatively weak quarterly earnings report. Based on the information in the report, investors feel that the stock price will not continue to rise, so they engage in profit taking to lock in their gains.
When Does Profit Taking Occur?
Profit taking is especially common when there is a general decline in the economy, or when an industry is now subject to an increased amount of expensive regulation. Other scenarios that can trigger profit taking are when an industry is coming under profit pressure from outside the industry, or when a company has missed on one or more of its key performance indicators.
When many investors decide to engage in profit taking, this can trigger a broad sell-off of securities, which can trigger a decline in the major stock market indices.
Example of Profit Taking
As an example of profit taking, Mr. Smith has 1,000 shares of Awesome Corporation, which he purchased for $30/share, for a total investment of $30,000. Many months later, the market price of these shares has risen to $40, which increases the value of Mr. Smith’s investment to $40,000. At this point, Mr. Smith thinks that the market has reached its peak, so he decides to sell, generating a profit of $10,000. This is an example of profit taking, where an investor is selling an investment in order to realize a gain. The amount of income tax he will owe on this profit taking will depend on the duration of his holding period, but there will be a tax, resulting in a reduced net gain on the transaction.