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 by
legendary 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, see Financial 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 the futures 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 Journal and 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.
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, see Trading Systems: Run With The Herd Or Be The Lone
Wolf?)
The Rules
Turtles were taught very specifically how to implement a trend-following strategy. 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 downside breakouts. 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, see Defining Active Trading.)

Figure 1: Buying silver using a 40-day breakout led to a highly
profitable 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:

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, read The Importance Of A Profit/Loss Plan.)
Use the average true range to 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, see Measure 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 large
drawdowns.
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 buy breakouts and close the trade when prices start
consolidating or reverse. Short trades 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, see The Anatomy of Trading
Breakouts.)

Despite its great successes, however, the downside to turtle trading is at least as great
as the upside. Drawdowns should 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
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.