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2011-07-19 12:29:39
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:
The big money in trading is made when one can get long at lows after a big
downtrend.
It is not helpful to watch every quote in the markets one trades.
Others' opinions of the market are good to follow.
If one has $10,000 to risk, one ought to risk $2,500 on every trade.
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.
by Michael Carr, CMT
Mike Carr, CMT, is a member of the Market Technicians Association and editor of
the MTA's newsletter, Technically Speaking. He is a full-time trader and
writer.