Do you believe that you are the kind of trader that will perform better with hard-and-fast rules? If not, you are not an anomaly. Many novice traders start the investment process by using a discretionary trading process but have little experience, and when the markets become problematic, they get flustered.

Successful traders often rely on the use of methods or a trading plan for success. By creating rules for trading, you can remove the emotional element that humans portray. A systematic approach to trading follows the rules and does not succumb to difficult emotional situations like making or losing money.

In 1983, trader Richard Dennis and William Eckhardt engaged in an experiment to prove whether trading could be taught. This Turtle trading experiment incorporated the Turtle Trading method.

Can Non-Professional Traders Learn a Trading System?

The experiment’s goal was to determine if a novice could be taught a Turtle trading system and become successful. Dennis believed he could create such a system, and Eckhardt thought it was a trader that made the Turtle trading system tick. The question is whether the trader makes the strategy or the strategy makes the trader.

The experiment was named the Turtle Experiment. Dennis called his students “Turtles” after recalling turtle farms he had visited in Singapore and deciding that he could grow traders quickly and efficiently as farm-grown turtles.

What Was the Turtle Trading Strategy?

The Richard Dennis strategy was a basic trend-following strategy. Students were instructed to use hard-and-fast Turtle trading rules, and they were told that if they did not veer from the path, they would be successful. The benefit of a trend-following strategy is that it can capture robust gains but the downside of the strategy is that it often loses more times than it wins.

This concept, where you can lose more times than you win, and still be successful goes to the heart of proper risk management. If you win twice as much on a winning trade as you lose on an unsuccessful transaction, you can win 33% of the time and lose 66% of the time and break even. Here is a quick example. You win $2 per trade and lose $1 per trade and place 9-trades, winning three and losing six. The result is that you win three times and win $2 per trade earning $6. You lose six times and lose $1 per trade, which is also $6.

Most of the time, markets consolidate sideways. When the markets trend, you can make money as a trend following trader. Your goal is to ride the wave when it occurs and get off when the wave reaches the beach. The Turtle trading system also includes what assets you could trade, as well as a risk management scheme. Richard Dennis used his own money to perform the Turtle experiment.

How Did the Turtles Perform?

The upshot was that the Turtles performed outstandingly, and during the first 4-years of their existence, experienced a growth rate of 80% CAGR (compounded annual growth rate). At that rate, $10,000 turns into $100,000 in four years.

The Turtle Experiment

Dennis did substantial screening before picking the individuals that would participate in the Turtle experiment. He wanted to make sure that the people chosen had the aptitude to follow the trading instructions. According to Dennis, it’s one thing to understand a strategy and a different to implement the instructions.

Dennis placed an ad in The Wall Street Journal, and thousands applied. After going through a rigorous application process, 14 traders would make it through the first Turtle program. Several true and false questions were used to sort through the thousands of applicants. For example, one of these asks, “It is not helpful to watch every quote in the markets one trades.” Another question was, “If one has $10,000 to risk, one ought to risk $2,500 on every trade.”

The Original Turtle Trading Rules

The Turtles learned the nuances of a trading strategy. There were specific instructions on how to implement a trend-following strategy. A catch saying “the trend is your friend” is a motto of the Turtle strategy. The concept is simple, and Turtle trader rules made the process easy to follow. You purchase futures contracts that are breaking out after consolidation has formed a defined range. For example, you might be buying futures contracts at a 4-week high or selling futures contracts when they hit a 4-week low. These concepts were all part of the Turtle system rules.

The strategy is a “pure” technical analysis strategy where prices governed the entire decision process. Dennis told the Turtles that they should not allow factors such as TV commentators or News Paper Journalists to impact their trading criteria. They incorporated strict risk management parameters for their initial stop-loss levels to minimize risk of loss.

To determine the position size, you would calculate the historical volatility of each asset. The average true range is an indicator that can measure volatility. Volatility is the percent move that you should expect from an asset calculated annually. The Turtles were instructed to take more significant positions when the volatility was subdued and smaller when the volatility rose.

The maximum trade size a Turtle would take on any position was 2% of the account balance. One key motto is that the returns are a function of the risk that you take. If you want to generate significant returns, you need to get comfortable with bigger drawdowns.

A Turtle trading strategy’s risk versus reward profile is geared toward making more on your winning trades than you lose on your unsuccessful trades. Since the markets only trend 20-30% of the time and consolidate most of the other time, it’s helpful to understand that you might experience drawdowns in an effort to capture a trend eventually.

Did The Turtle Experiment Work?

There are several anecdotal reports of the success of the Turtle trader program. According to former Turtle Russell Sands, Dennis personally trained two separate classes of Turtles who earned more than $175 million in only five years. Dennis proved that beginners could successfully learn how to trade if you provide them with specific rules to follow.

The Turtles strategy can be mimicked today, and if you are willing to accept large drawdowns, you will likely be successful over time. Dennis employed the system to look for market breakouts that will continue to trend higher or lower. You can also alter the risk management rules a bit to meet your personal risk parameters.

The transactions can be in the form of long and short trades. According to the same principles under this system, short transactions must be made because a market experiences uptrends and downtrends.

Dennis needed his students to understand that drawdowns were part of the strategy and how you dealt with a drawdown was as important as how you handled success. Trend-following systems generally experience significant drawdowns, as the reward that you garner is a function of the risk that you take. This scenario occurs because most breakouts tend to be false moves, resulting in many losing trades.

What Securities did the Turtles trade?

The Turtles were required to trade liquid markets. The size of their positions were relatively large, and therefore, they needed to avoid experiencing slippage when they entered and exited trades.

Grain futures were off-limits because Dennis himself was maxing out his trading account trading these future products. Many of the transactions consisted of 10 and 30-year treasury bond futures contracts along with U.S. Treasury bills. Trading forex futures such as the British Pound, the Japanese Yen and the Canadian dollar helped diversify the portfolio further.

Other commodities such as energy products like crude oil, heating oil, and gasoline were on the menu: the Turtle’s also traded coffee, cocoa, and sugar. The Turtles were also allowed to trade precious and base metals such as gold, silver, and copper. They also would focus on index futures such as the S&P 500 futures contract.

Position Size

The Turtle Traders were provided a sophisticated position sizing algorithm. They would change the size of their position based on the volatility of the asset. The size of the position was a function of the volatility of the market. The larger the volatility, the smaller the position. The formula Dennis provided helped the Turtle’s figure out how much of each contract they should hold at any point during the trading process.

By changing the size of the position, the Turtles were able to generate consistent returns. For example, the more significant position size created when Turtle’s traded Eurodollar futures contracts offset the low volatility in the price of that futures contract. The formula was based on the 20-day exponential moving average of the True Range of the underlying asset. This method created a system that described the dollar volatility per point.

For example, the Turtles would build a position which was one percent of the account divided by the dollar volatility. The units for each market will vary, and the unit value will also fluctuate as the 20-day exponential moving average changes over time. A single position was limited to 4 units. For holding a position in multiple markets, the Turtles could have a total of 10 units.

Entering Trades

The Turtles used two entry systems. They used a 20-day breakout system to enter one unit when the price moved above the 20-day high or dropped below the 20-day low. Turtles would also skip a trade if the last trade was a winner.

Turtles also used a longer-term system based on the 55-day breakout. The Turtles entered one unit when the price moved above the high of the last 55 days or dropped below the low of the previous 55 days. Trades were entered on the market close to confirm the trading criteria.

Adding to Positions

The Turtles added to winning positions to take advantage of the movement of a trend. They used something called pyramiding, which is taking a more prominent position as the price moves favorably. This criterion is based on the transaction price and not the actual breakout price.

How Turtles Exited Positions

At the outset of each trade, a stop loss is placed above or below the entry price. The Turtles used a volatility-based system to exit their positions. The short-term trading system used a 10-day low on a long position and a 10-day high on short positions.

The Turtles would use a 20-day high or low on long and short positions for the long-term trading system, respectively. The key to the success of the Turtle’s was their ability to be disciplined. It’s not easy to wait for a 10 or 20-day low or high when the market moves against you. These criteria are used to make sure that a trend is not broken and needs to be observed.

Is the Turtle Trading Strategy Still Relevant?

The Turtle Trading system devised by Richard Dennis worked very well for traders in the 80’s. Several tests, including one conducted by Trading Blox, backtested the Turtle Trading System and found that returns were completely flat between 1996 and 2009. However, the system generated returns of 216% between 1970 and 1986, the Turtle trading era.

So it’s entirely possible that the Turtle Trading system was perfect for the era that Dennis was using it. The method in its original form has not worked well in recent years. What is not clear is whether small changes to the system will reveal positive results.

When the Turtle trading system was developed, access to computers that could back-test a strategy was difficult to come by. There were no personal computers that could run systems that could quickly determine if a systematic approach would be successful. Today, retail traders have plenty of access to trading platforms that provide back-testing capabilities. The strategy that was used by the Turtles could be widely replicated today.

Today, for a trend-following strategy to work, you need to have a more sophisticated way to manage your risk. The stop loss criteria that the Turtles used would likely generate losses that would create too large of a drawdown. Additionally, traders today have access to a wide variety of technical analysis tools that can pinpoint a specific type of entry criteria.

Several technical indicators have been developed based on the Turtle Trader method. These indicators can be successful during trending market conditions. Of course, when the market isn’t trending, these indicators generate losses. To avoid this you can add a filter that can help you determine if the market is trending or consolidating.

For example, if you are planning to use a moving average crossover, such as when the 20-day moving average crosses above (or below) the 50-day moving average, you might consider evaluating momentum to see if the price is accelerating or decelerating.

You can also use momentum oscillators that measure overbought and oversold levels to determine if the asset’s price has moved too-far-too-fast. This information can help you decide whether you should enter at a breakout level or wait for a slight pullback. For example, if you receive an entry criteria when the RSI is printing a reading of 80, you might consider letting the market pullback (on a buy signal) before entering your trade.

The Bottom Line

The Original Turtle Trading Story describes a bet between Richard Dennis and William Eckhardt. Dennis, a master trader, believed it was a system that made the Turtle trader, while Eckhardt thought that the trader made the system. Dennis taught his Turtle traders to follow specific tasks and help mold many of  them into excellent traders. And he ultimately won the bet that he had made with Eckhardt.

The Turtles were given specific risk management instructions to calculate their positions based on formula-driven volatility. Higher volatility assets had reduced position sizes. The entry criteria were based on a breakout of the price over a specific period. You are allowed to add to a position when the trend moves your way.

The assets that the Turtles traded were liquid. Since significant positions needed to be taken to drive the returns, you needed assets that allowed for limited slippage when entering and exiting a trading position. The position size was based on the number of units. Turtles were given the maximum number of units they could take at any one time.

The system is a trend-following system that can have significant gains, but you must be willing to accept large drawdowns to accomplish this task. Since breakout strategies often experience several false breakouts, you need to access a set of proven criteria to help you realize more significant returns.

The Turtle system has concepts that still work, but the strategy in its original form has not yielded positive returns as of late. Recent testing shows flat returns. Modifications of the idea have shown solid results. Trend following could to be accentuated with momentum and mean reversion to compete in this current age. If you are interested in more information about the Turtle story, you can read “The Complete Turtle Trader” by Michael Covel.