Book summary:

The famous turtle program was the fruit of the debate between Richard Dennis and William Eckhardt, on the issue of whether traders are can be nurtured. Dennis believed it can but Eckhardt thought otherwise. Hence, they decided to make a bet by recruiting people from diverse background and most without experience. The book covered the entire story of the turltes, from the beginning of the program to what happened after the program. Instead of summarizing the process of how the turtles were hired etc, I will only focus on the information and attributes that makes one a good trader which I picked up from the book. In addition, I will introduce the turtle trading method.

What makes a successful trader?

Courageous probability trader

A successful trader thinks in terms of odds and always enjoys playing the game of chance. He or she will experience losses but must be able to hold the nerves and keep trading like they have yet lost. Richard Dennis was $10mil down in a single day but was able to finish off with a $80mil profit for the year. Something that makes “mere mortals lose sleep”. It was said that great traders like Dennis, process information differently from majority of the investors. He does not take conventional wisdom for granted or accept anything at face value. “He knew that traders had a tendency to self-destruct. The battle with self was where he focused his energies.” During the interviews with the potential turtles, one of the abilities he was looking for was “to suspend your belief in reality”.

“Great training alone was not enough to win for the long run. In the end, a persistent drive for winning combined with a healthy dose of courage would be mandatory for Dennis’s students’ long-term survival.”

Eckhardt emphasized that they are not mean reversion traders who believe the market will always return to the mean or fluctuate around the mean. Dennis and co. believe the market trends and often come unexpected, which also means the payout will be very rewarding.

Emotionless and disciplined

Dennis taught the turtles not to think trading in terms of money so they can detach themselves from it and no matter what their account size, they would still be able to make the correct trading decisions.

The turtles were taught to be trend followers where they used a system of rules to tell them the bet size, entry and exit points. Rules “worked best” as they eliminate human judgements which do not work well in the market. That being said, even if rules are followed religiously, traders are not expected to be right all the time and it is crucial that they cut their losses and move on when they are wrong. It is important to make every trade a good trade rather than a profitable trade. As long as good trades are made, profits will come in the long run.

The hypothesis is that two traders who have the same system, risk aversion and situation, will take the same course of action. It is human nature that caused different traders to react differently. Eckhardt said, “You are not special. You are not smarter than the market. So follow the rules. Whoever you are and however much brains you have, it doesn’t make a hill of beans’ difference.”

Following the trend and rules are easier said than done. Dennis said, “To follow the good principles and not let fear, greed and hope interfere with your trading is tough. You’re swimming upstream against human nature.”

Eckhardt also emphasized that trading must be “memory-less”, that is one should focus on the current state and not let past trades affect him/her. Thus, they only adjust the amount to trade to the money they currently have, and not how much they have lost or won along the way. They cannot afford not to enter after a second breakout has occurred even though they lost money on the first breakout. It is taught that entry to the market should be random and only manage the trades thereafter. Hence exiting a trade becomes more important than entering a trade. “Turtles were taught that they had to exit with a small loss, because they don’t know how far it could drop, they got out.” “It is better to risk taking many small losses than to risk missing one large profit.” Analogous to a movie producer or a book publisher, where they will fund 10 movies/books, with only one bestseller but still able to make profits. They just have to limit their portfolio risk so that they can “live to fight another day”, and they will win with that little edge they have in the long run.

Price is everything
Price is the single most important piece of information the trend followers rely on – Dennis said, “[Initially, I] thought that intelligence was reality and price the appearance, but after a while I saw that price is reality and intelligence is the appearance”. This is very unlike the fundamental investors who look into the companies annual reports to make investment decisions and not solely on price. Hence, fundamental investors do not have the flexibility to trade in a variety of markets like commodities and bonds. On the other hand, trend followers can trade in any market as long as it has price and trends. Markets are participated by humans and humans are affected by emotions, “…[W]e’re trading mob psychology. We’re not trading corn, soybeans, or S&P’s. We’re trading numbers.”

The turtle traders are to buy into trends, both when market goes up and down. Unlike value investors, they do not judge price as too high or too low. They enter when the rules tell them to.

Turtles Trading method

Dennis wanted to make his trading to “resemble the house”, with the little edge against the gamblers was enough to keep casinos profitable. Percent accuracy meant nothing to Dennis and co. “It’s not about the frequency of how correct you are; it’s about the magnitude of how correct you are.”

The monthly expectation of the turtles beats the monthly expectation from buy and hold market indexes.

Contrary to “buy low sell high”, turtles buy high and sell higher or sell low and buy lower.
Turtles practised 2 systems:

System One (S1) – Buy at 4 week high breakout and sell at 2 week low.
System Two (S2) – Buy at 11 week high breakout, and sell at 4 week low.

S2 generally ensured the turtles do not miss out the longer trends that were filtered away by S1.

One can change the breakout lengths and test to verify its effectiveness, but a robust system should not have much changes. Fundamental rules are to remain after the changes and complicated indicators should not be added into the system. It is important to keep it simple if not the system will not work.

Turtles knew that as trend followers, they cannot pick the market bottom or the top. They live with the “middle” as what the market can reward them.

Another important rule of the turtle is to size their trades. The turtles have a standard method to calculate the amount of money they can “test” the market. When they are right, they will add on to the winning positions and capitalize on their winning streak.

The turtles sized their position according to market volatility. They used the term Average True Range (ATR or simply “N” in their jargon) for every trade. ATR is the 20 day moving average of true ranges (TRs). Here is how TR is derived:

Take the absolute value of the following
– Difference between today’s high and today’s low
– Difference between yesterday’s close and today’s high
– Difference between yesterday’s close and today’s low

The highest absolute value will be TR. Usually, turtles will make an initial bet of 2% of their capital and place a stop loss at 2 ATR below entry price. 2% of their capital is also equivalent to a unit of investment.

Account risk = 2% of capital
Contract risk = ATR x unit price x 2 (2 ATR stop)
Number of contract = account risk / contract risk (rounded down to nearest whole number)

Such method will allow the trader to take a larger position when the market volatility is low. The maximum they will add to their winning position is 5 units.

To limit their risk, they trade in uncorrelated markets at the same time. As they do not know which market would trend big, they have to stay involved in all as they cannot afford to miss a big run.

When the market shows no trend, traders have to remain discipline and do no trades according to the rules.

It must be remembered that the higher the leverage, the bigger the drawdown will be. Hence, it really depends on the risk appetite of the trader.