The “iron triangle” links protective stop with position size. It makes you enter each trade with a clear stop in mind, but as time goes on, you’ll face a choice. On the one hand, you may leave both the stop and the profit target in place. On the other hand, you may want to move your stop to protect a share of your paper profits. Of course, you may only move your stops in one direction—up for longs and down for shorts. You may tighten your grip on a trade but never loosen it.
Talk about patience! Had you bought KO at the level we discussed, you would have had to wait nearly a year before the uptrend got going. Prices did sink below the entry level but never violated their stop. At the right edge of the chart, prices have just broken out above their 2004 high. Several indicators are tracing bearish divergences. Shall we hold to our initial target of near $60 or take profits here? This is the sort of dilemma that long-term traders have to deal with.
Some traders use trailing stops, moving them in the direction of the trade. Others may start out with a traditional stop but then, as prices approach their target, decide that the market wants to go farther. A trader who thinks that the trend is likely to move beyond his initial target may cancel his profit-taking order and switch to a trailing stop. This would allow the trade to run ...