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Turtle Trading: A Market Legend

Few people associate Eddie Murphy, Dan Ackroyd and the 1983 movie "Trading

Places" with one of the greatest trading stories of all time. However, in the same year

the movie was released, a real-life experiment along similar lines was carried out bylegendary commodity traders Richard Dennis and William Eckhardt. In the end, life

imitated art and the experiment proved that anyone can be taught to trade well. (For

related reading, seeFinancial Careers According To Hollywood.)

The Turtle Experiment

By the early 1980s, Dennis was widely recognized in the trading world as an

overwhelming success. He had turned an initial stake of less than $5,000 into more than

$100 million. He and his partner, Eckhardt, had frequent discussions about their

success. Dennis believed anyone could be taught to trade thefutures markets,while

Eckhardt countered that Dennis had a special gift that allowed him to profit from trading.

The experiment was set up by Dennis to finally settle this debate. Dennis would find a

group of people to teach his rules to, and then have them trade with real money. Dennis

believed so strongly in his ideas that he would actually give the traders his own money

to trade. The training would last for two weeks and could be repeated over and over. He

called his students "turtles"after recalling turtle farms he had visited in Singapore and

deciding that he could grow traders as quickly and efficiently as farm-grown turtles.

Finding the Turtles

To settle the bet, Dennis placed an ad in The Wall Street Journaland thousands applied

to learn trading at the feet of widely acknowledged masters in the world of commodity

trading. Only 14 traders would be make it through the first "Turtle" program. No one

knows the exact criteria Dennis used, but the process included a series of true-or-false

questions; a few of which you can find below:

1. The big money in trading is made when one can get long at lows after a big

downtrend.

2. It is not helpful to watch every quote in the markets one trades.

3. Others' opinions of the market are good to follow.

4. If one has $10,000 to risk, one ought to risk $2,500 on every trade.

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5. On initiation one should know precisely where to liquidate if a loss occurs.

For the record, according to the Turtle method, 1 and 3 are false; 2, 4, and 5 are true.

(For more on turtle trading, seeTrading Systems: Run With The Herd Or Be The Lone

Wolf?)

The Rules

Turtles were taught very specifically how to implement atrend-followingstrategy. The

idea is that the "trend is your friend", so you should buy futures breaking out to the

upside of trading ranges and sell short downsidebreakouts.In practice, this means, for

example, buying new four-week highs as an entry signal. Figure 1 shows a typical turtle

trading strategy. (For more, seeDefining Active Trading.)

Figure 1: Buying silver using a 40-day breakout led to a highlyprofitable trade in November 1979.Source: Genesis Trade Navigator

This trade was initiated on a new 40-day high. The exit signal was a close below the 20-

day low. The exact parameters used by Dennis were kept secret for many years, and

are now protected by various copyrights. In "The Complete TurtleTrader: The Legend,

the Lessons, the Results" (2007), author Michael Covel offers some insights into the

specific rules:

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Look at prices rather than relying on information from television or newspaper

commentators to make your trading decisions.

Have some flexibility in setting the parameters for your buy and sell signals. Test

different parameters for different markets to find out what works best from your

personal perspective.

Plan your exit as you plan your entry. Know when you will take profits and when

you will cut losses. (To learn more, readThe Importance Of A Profit/Loss Plan.)

Use theaverage true rangeto calculate volatility and use this to vary your

position size. Take larger positions in less volatile markets and lessen your

exposure to the most volatile markets. (For more insight, seeMeasure Volatility

With Average True Range.)

Don't ever risk more than 2% of your account on a single trade.

If you want to make big returns, you need to get comfortable with largedrawdowns.

Did It Work?

According to former turtle Russell Sands, as a group, the two classes of turtles

personally trained by Dennis earned more than $175 million in only five years. Richard

Dennis had proved beyond a doubt that beginners can learn to trade successfully.

Sands contends that the system still works well, and said that if you started with

$10,000 at the beginning of 2007 and followed the original turtle rules, you would have

ended the year with $25,000.

Even without Dennis' help, individuals can apply the basic rules of turtle trading to their

own trading. The general idea is to buybreakoutsand close the trade when prices start

consolidating or reverse.Shorttrades must be made according to the same principles

under this system because a market experiences both uptrends and downtrends. While

any time frame can be used for the entry signal, the exit signal needs to be significantly

shorter in order to maximize profitable trades. (For more, seeThe Anatomy of Trading

Breakouts.)

Despite its great successes, however, the downside to turtle trading is at least as great

as the upside.Drawdownsshould be expected with any trading system, but they tend to

be especially deep with trend-following strategies. This is at least partly due to the fact

that most breakouts tend be false moves, resulting in a large number of losing trades. In

the end, practitioners say to expect to be correct 40-50% of the time and to be ready for

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large drawdowns.

Conclusion

The story of how a group of non-traders learned to trade for big profits is one of the

great stock market legends. It's also a great lesson in how sticking to a specific set of

proven criteria can help traders realize greater returns. In this case however, the results

are close to flipping a coin, so it's up to decide if this strategy is for you.