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Turtle Trading: History, Strategy & Complete Rules

The Turtle Traders experiment was conducted in the early 1980s by Richard Dennis and William Eckhardt to see whether anyone could be taught how to make money trading. The experiment involved taking a random group of people, teaching them a set of rules to follow, and seeing how successfully they traded.

In this post, we’ll look at the rules of Turtle Trading, how successful the experiment was, and whether the Turtle Trading Rules still work in today’s market.

If you’re not interested in the history or if the rules still work today, here you can download the original turtle rules.

The Beginning

In the early 1980s, Richard Dennis was a well-known trader who found considerable financial success, starting with less than $5,000 and turning it into over $100 million. Dennis’s partner, William Eckhardt, believed Dennis’s success was only possible because Dennis had a unique gift. Dennis disagreed. Dennis based his trading on a specific set of rules. He thought anyone who learned and followed his rules could become a successful trader.

The two regularly discussed this topic, and finally, they decided to experiment to see who was right. Dennis would find a group of people, spend two weeks training them on how to follow his trading rules, and then let them start trading. He could then repeat this process over and over. Dennis felt so confident in his methods that he decided to give the traders his own money to trade. Bill Eckhardt and Richard Dennis can be seen below.

Richard Dennis & Bill Eckhardt

The Turtles

Dennis began referring to his students as “turtles” since he believed he could quickly and efficiently produce traders the same way he had seen turtle farmers in Singapore efficiently and rapidly create turtles.

Dennis found his original turtles by placing an ad in The Wall Street Journal. Original Turtle Trader Ad

At this time, Dennis was a well-known trader offering everyday people the chance to make large amounts of money. Not surprisingly, thousands of people applied. From these thousands, Dennis picked only fourteen to be part of the inaugural group.

Dennis never explained how he chose his turtles from the thousands that applied. We do know that a set of true or false questions was one part of the screening process. The 63 true or false questions Dennis asked included the following:

Big money in trading is made when one can get long at lows after a significant downtrend. Diversification is better than always being in 1 or 2 markets. Other’s opinions on the market are good to follow. The majority of traders are always wrong. If one has $10,000 to risk, one ought to risk $2,500 on every trade.

Again, we don’t know the exact criteria Dennis used to pick his turtles so that they may have disagreed initially with his methodology. Still, it seems likely that these questions allowed Dennis to find turtles who already agreed with his trading method’s most important concepts. This is a crucial point to keep in mind.

The turtle trader experiment is often compared to picking a random person off the street, providing them with two weeks of training, and then sending them off to become millionaires. While the turtles were not successful and well-known traders, they knew who Richard Dennis was, wanted to train with him, knew enough about trading to provide answers to his questions, and most likely already had similar trading beliefs to Dennis. This is not to say Dennis did not teach them a lot, only that when we discuss the results of the experiment, it’s useful to keep in mind that these were not people plucked randomly from off the street.

What the Turtles Learned

During the two week training, Dennis taught the turtles his Turtle Trading rules and philosophy. This training taught the turtles to approach trading with the scientific method, which would be the philosophical foundation for all of their trading. The scientific method relies on numerical data that can be observed and measured. The steps of the scientific method are:

  • Define the question
  • Gather information
  • Form a hypothesis
  • Design an experiment to test the hypothesis
  • Perform the experiment and collect data
  • Analyze the data from your experiment
  • Interpret the data

If the data matches the hypothesis, you accept the theory and report the findings. If the evidence does not match the hypothesis, you refine the thesis and begin the process over.

Dennis taught his turtles to rely on the scientific method to minimize the psychological impacts of trading that could cause traders to make mistakes and lose significant amounts of money. In this respect, Dennis was ahead of his time. This was 1983, and Dennis put into practice some of the basic concepts of “prospect theory, “ which Daniel Kahneman would go on to win a Nobel Memorial Prize in Economic Sciences in 2002.

The Turtle Trader Core Concepts and Questions

Beyond the use of the scientific method, Dennis also taught the turtles to internalize some core concepts that speculators had been using for over a century. The core concepts Dennis taught were:

“Do not let emotions fluctuate with the up and down of your capital.” “Be consistent and even-tempered.” “Judge yourself not by the outcome, but by your process.” “Know what you are going to do when the market does what it is going to do.” “Every now and then, the impossible can and will happen.” “Know each day what your plan and your contingencies are for the next day.” “What can I win and what can I lose? What are the probabilities of either happening?”

You’ll notice that all of these core concepts sound good but provide minimal concrete guidance. This is why Dennis also gave his turtles five questions they could use to add more precision to their trading and apply the concepts more concretely. The five questions Dennis taught his traders to always have an answer to were:

What is the state of the market? What is the volatility of the market? What is the equity being traded? What is the system or the trading orientation? What is the risk aversion of the trader or client?

Let’s look at the importance of each of these questions and how it informed the turtle’s decision making.

1. What is the state of the market?

This means, what is the price and direction at which the market is currently trading? For example, if IBM has a share price of $125 that has moved up from $100 with higher highs and higher lows, that uptrend is the state of that market. While this may seem like an overly simplistic place to start, Dennis’ method required paying attention to the present, instead of focusing on the market of yesterday or tomorrow.

2. What is the volatility of the market?

In investing, volatility is defined as “a statistical measure of the dispersion of returns for a given security or market index”. This means that the more the price fluctuates, the higher the level of volatility. Generally, the higher the level of volatility, the higher the risk.

When Dennis, Eckhardt, and the turtles used the term volatility, they meant a certain kind of volatility, specifically how much a market goes up and down daily. For example, let’s say one share of IBM traded at $125 on average, but from day to day, the price fluctuated between $123 and $127. They would use the term “M” to describe daily market volatility. So, they would say M equals four, for this example of IBM.

3. What is the equity being traded?

A key component of Dennis’s strategy relied on always knowing how much money you had available since his rules were based on the size of the account at that moment. Therefore, implementing the rules required knowing exactly how much you had in the bank.

4. What is the system or the trading orientation?

The strategy the turtles learned required reliance on specific rules and systems. Abiding by this strategy meant entering and exiting the market at predetermined prices. The turtles would base every decision on these systems. Knowing the system or the trading orientation meant knowing when you would buy or sell instead of basing your decisions on whether it “felt right”.

5. What is the risk aversion of the trader or client?

Any investing strategy requires an awareness of how much risk is or is not acceptable, and Dennis’ was no different. While some level of risk is involved in every investment, deciding upon the right amount was incredibly important; too little and you missed out on making a more substantial profit, but too much and you could suffer ruin.

The Turtle Trading Method

Dennis trained the turtles to be trend-following traders. This means the turtles would take advantage of “trends” in the market. When they found a trend, they would follow it to profit from capturing most of the trend, whether that be up or down.

Trend followers do not try to forecast how much a price will move. Instead, a trend follower follows a strict set of rules for entering the market and when to exit the market. The goal of following these rules is to limit the influence of other factors and allow the trader to make decisions without emotional judgments impacting trades.

The concept of trend following is in contrast to other trading methodologies that base trading decisions on fundamentals. The trend-following method of trading teaches that traders do not need to know the ins and outs of a specific company, industry, etc. Once a trader learns how to follow trends, the trader can apply that methodology across different companies, industries, assets, etc.

The concept of trend following was not new. Richard Donchian was a well-known trader who had been using and teaching the trend following approach to trading since the 1950s. Donchian and his method influenced many successful traders, including Dennis and Eckhardt.

The Systems - System 1 and System 2

The rules for trading were at the heart of what Dennis taught his turtles. He drilled into them that making a consistent profit was not about being smarter or luckier - it was about following the rules. So, what were these rules?

The full rules are described in Michael Covey’s: The Complete Turtle Trader: How 23 Novice Investors Became Overnight Millionaires, but Business Insider has provided a summary of the rules the Turtle Traders used.

In Dennis’s trend-following method of trading, trades were based on price channel breakouts. The strategy had two systems, which were referred to as S1 and S2. Both of these systems were used for trading liquid futures. Here’s the strategy for each.

System 1 (S1)

This was the more aggressive and short-term of the two trading systems. For a long position, an entrance was made (you would buy) when the current price exceeded the high price of the previous twenty days. If you wanted to take a short position, the reverse was true: an entrance was made (a short position) when the current price was lower than that of the previous twenty days. But this signal would be ignored if the previous breakout signal would have led to a winning trade. The signal to exit in this system was a ten-day low (for long positions) or a ten-day high (for short positions).

System 2 (S2)

This system took a slightly longer approach (though by no means a long-term strategy). It also came with a bit less risk than S1. The signal to enter using this system, for a long position, was when the current price exceeded the high of the previous 55 days. For a short position, the signal to enter was when the price dipped below the low of the last 55 days. Unlike with S1, the signal to enter the market applied whether the preceding breakout was a winner. The signal to exit for S2 was when the price hit a 20-day low (for long positions) or high (for short positions).

The goal of both of these systems was to help the turtles know when to enter and exit the market. The turtles were trend following, but trends are often difficult to see as they’re happening. Only in hindsight do they become apparent. The entrance signal, therefore, helped alert the turtles to a potential trend.

Once a trend has been found, knowing when to exit the strategy is potentially even more challenging, and greed and fear can often cause poor exits. The exit strategy of both S1 and S2 aimed to eliminate the impact of these two emotions. If a turtle made a trade and profits kept increasing, the turtle might be tempted to stay in the position and make even more money, but if the system the turtle was using said to exit, the turtle had to exit. Conversely, if the turtle could exit the strategy and make a profit, the turtle may fear staying in too long and losing that profit, but if the exit strategy didn’t tell the turtle to exit, the turtle had to stick with that trade.

One of the hardest parts of trading is deciding when to enter and exit the market. That’s why these two systems were the core of what Dennis taught his turtles, but there are other factors traders must also consider, which is why Dennis taught his turtles some additional rules that allowed them to filter their trades further. These additional rules related to position sizing and the use of stops.

The Rules - Position Sizing

Position sizing requires adjusting the size of a position based on the dollar volatility of that market. Since more volatility means more risk, the goal was to find investment opportunities with similar risk per dollar invested. This way, the turtles could diversify their portfolio among investments with similar levels of risk.

Dennis taught the turtles how to quantify risk using a series of formulas and then limited the amount of risk a turtle could take on. Dennis and his turtles used “N” to represent the underlying volatility of a market. The turtles calculated N by taking the average price movement of the last twenty days.

Dennis taught the turtles to build positions using what he referred to as “units”. One unit was calculated by taking one percent of the account and dividing it by N times the dollars per point (market dollar volatility). A Unit was then a measure of a position’s risk and all the positions in that portfolio.

The formula for calculating a Unit looks like this:

Unit = 1% of Account N x Dollars per Point

The Rules - Stops

Stops were another essential part of the Turtle Trading strategy. Dennis taught his turtles to decide ahead of time at what point the turtle would cut any losses and move on. The goal was to keep losses small by limiting the impact emotions could have on a trade.

This rule was non-negotiable. Once the investment reached the predetermined stop price, the turtle had to exit the strategy. This helped the turtles avoid a common trap among many traders. Often when a trader places a trade, if the trade appears to be losing money, the trader will hang on in the hopes that things will turn around. While this may happen, it rarely does. The trader who can accept the loss and move on will often lose far less than the trader who clings to a bad investment.

The Results

Now that we know the rules the turtles used, the question becomes - how successful were they? The answer - very successful.

The experiment lasted for five years. Once these five years were up, the turtles had made a combined profit of $175 million. Not all traders made it to the end, and due to the highly volatile nature of the Turtle Trading system, there were also plenty of losses among the turtles. Still, ultimately, Dennis proved himself correct in believing that anyone can be taught how to trade successfully.

Fast Moving Breakout Strategy Visual Guide

You can see the fast breakout trading system below from forex.com.

Fast System

Application in Today’s Market

If the turtle’s made $175 million in five years, you may be wondering how soon you can start implementing the Turtle Trading strategy in your portfolio. Not so fast.

The Turtle Trading strategy was implemented in the 1980s, almost forty years ago. In the last forty years, the market has changed dramatically, and the strategy the turtles used may no longer work in today’s market.

In general, most popular trading systems with specific rules and guidelines eventually stop working as more traders using similar strategies arbitrage away the profits. There are other potential reasons why the Turtle Trading strategy may no longer work. But Jerry Parker, a well-known turtle who still uses the system today, says that it’s timeless.

What Happened to Richard Dennis?

An interesting footnote to the story of the Turtle Trading experiment is what happened to Richard Dennis. Dennis made his first million dollars before turning 25. At the height of his trading success, he became known as the “Prince of the Pit”. In 1986 alone, Dennis made $80 million. During this time, Dennis’s name joined those of other titans in the industry such as George Soros and Michael Milken. But his success didn’t last.

Dennis’s strategy always came with high levels of volatility. On some days, Dennis could be millions of dollars down, but he believed that the wins outweighed the losses. And for a long time, they did. But eventually, a time came when this was no longer the case. Between 1987 and 1988, at the same time Dennis’ turtles were finishing their five-year experiment, Dennis lost more than fifty percent of the assets he managed. Whether Dennis was strictly following his Turtle Trading system when he lost all this money is up for debate.

After this loss, Dennis retired from trading. His name now lives on far more in relation to his Turtle Trading experiment than for his successful trading career. But what about the turtles? Did they fare better than Dennis?

What Happened to the Original Turtles?

The turtles which made it through the experiment were those who followed the rules. Not all the turtles managed to make it, though. Some turtles were asked to leave the experiment after they struggled to abide by the rules Dennis had taught his turtles.

For most of the turtles, the most challenging part of following the rules was the exit strategy, which required waiting for a new low. At times, this meant watching 20%, 50%, or even 100% of profits disappear. Apparently, one turtle was let go before the end of the first year because he failed to follow the exit strategy rules.

Those who followed the rules and remained in the experiment made large profits by basing their trades on the Turtle Trader rules. Some even went on to have successful careers as commodity traders. But not all the turtles found success. One of the turtles, Curtis Faith, went on to start his own money management firm. The firm, Acceleration Capital, failed in a rather dramatic fashion, but it’s unclear how well Faith followed the Turtle Trader rules. Jerry Parker, on the other hand, still manages Chesapeak Capital.

The Takeaway

There are a lot of ways to interpret the results of the Turtle Trading experiment. We could look at the success of the turtles and say that anyone can be taught to trade. We can look at Dennis’s massive losses and see a cautionary tale about highly volatile trading strategies. We could use the experiment to highlight the differences in the markets of the 1980s and today.

Personally, I find the Turtle Trading experiment a fascinating look at the power of emotions in trading decisions. Even with a clear-cut set of rules from someone considered at the time to be a master in his field, many of the turtles still couldn’t follow the rules, to the extent that many were asked to leave the experiment. Human nature and our best interests often conflict in trading. While it’s unclear if the Turtle Trading strategy would work in today’s markets, what is clear is that whatever trading system you use, you need to have a rational, thought-out basis for every trading decision you make and to stick with the system.

leo

Leo Smigel

Based in Pittsburgh, Analyzing Alpha is a blog by Leo Smigel exploring what works in the markets.