In the 1980s, the American trader Richard Dennis, famously known for trading a wide range of markets, entered into an interesting wager with his friend William Eckhardt. Dennis bet Eckhardt that he could teach anyone to trade and ‘grow,’ mirroring how baby turtles are farm-grown in Asia. This experiment came to be known as the turtle trading experiment.
The Turtle Trading Experiment
Calling his students ‘turtles,’ Dennis gave them his money and taught them several rules about the complete trading system. Dennis’ experiment aimed to provide a wholly mechanical approach and a set of rules that could help traders eliminate emotions from judgment. The idea was to help traders place their trades only based on rules and nothing else.
Dennis reasoned that even though he could publish all the rules in a newspaper, only a few traders would heed them since most traders avoid following rules rigidly. He mentioned that most people only follow the trading rules as a method of improvising when necessary and that deviating from the rules can affect trade performance.
What is turtle trading? Understanding the philosophy
The turtle trading strategy is a popular trend-following strategy that traders use to benefit from sustained momentum in the trading market. Used in many financial markets, traders employing this strategy look for breakouts, upsides, and downsides.
Through the experiment, Dennis decided to train 14 ‘turtles.’ He taught his students to create a mechanical strategy of following rules instead of relying on their ‘gut feeling.’ He trained a group of novice traders to follow the rules, and successful people were given $1 million of Dennis’ own money to manage. Dennis called this experiment the ‘turtle trading’ experiment.
A look at the turtle trading rules
Dennis’ ‘turtles’ had to employ the rules below to succeed as traders.
1)The trading markets rule
The first rule revolved around markets traded. As per this rule, the turtles had to trade futures contracts and look for highly liquid markets, letting them enter into trades without moving the markets in the absence of large orders. As such, the turtles traded commodities, metals, bonds, energy, currencies, and the S&P 500.
2)The position-sizing rule
In this rule, the turtles used a position-sizing algorithm to trade. The algorithm normalized the position’s dollar volatility by adjusting the trade size based on the market’s volatility. This rule improves diversification and ensures every position is the same, irrespective of the market.
3)The entries rule
The third rule for turtle trading was named the entries rule, in which Dennis’ students used two different entry systems. In the first entry system, a simple 20-day breakout was named the 20-day high or low, while the second used a 55-day breakout. The turtles had to ensure they took all the available signals and that missing even one signal could mean missing out on a huge winner, which could affect the overall returns.
4)The stop-loss rule
Dennis taught his turtles how to use stop-loss, asking them to use it all the time to ensure that no loss was ever too significant. They were asked to determine their stop loss before entering a position, thus defining their risk before placing the trade.
5)The exits rule
This rule focussed on exits. Dennis explained that exiting a position too early can limit a possible win, a common mistake most trend-following traders make. The turtles were taught to take many trades and shown how only a few could be turned into big winners, while the losses on most other trades were minimal.
6)The tactics rule
The final rule in the turtle trading system revolved around tactics. Per this rule, the turtles learned a few specifics about using limit orders and dealing with fast-moving markets. They also learned how to wait patiently before placing orders instead of rushing in and trying to get the best trading price, as most traders do. Dennis also taught them how to buy the strongest markets while selling the weakest ones to benefit from momentum.
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