The Turtle traders were a legendary group of traders coached by two
successful traders, Richard Dennis and William Eckhardt. They selected
10 people (turtles) with little to no prior trading experience and
turned them into winning traders by providing them with a set of very
precise trading rules.
The building block of the turtle traders’ success was their advanced
risk and money management and their position sizing approach. The
following 5 principles explain the most important risk and management
principles of the turtle traders’ strategy.
Volatility based stop loss orders of the turtle traders
The turtle traders used a volatility based stop loss order, which
means that they determined the size of their stop loss based on the
average ATR indicator (Average True Range). This also means that for every trade, they used a different stop loss size to react to changing market conditions.
The charts below show why this stop method is so powerful. Both
charts show a breakout scenario with very different price dynamics.
Whereas the left chart has very small candlesticks and a low ATR (low
volatility), the right chart shows larger candlesticks and a higher ATR
value (high volatility). How much sense would it really make to use the
same stop loss technique on both breakout trades? Correct, it wouldn’t
make any sense. A trader should use a small stop loss for the trade on
the left chart and a wider stop loss on the right chart to maximize his
reward:risk ratio and to minimize the chances of getting stopped out
during insignificant retracements.
Low volatility results in closer stops (click to enlarge)
High volatility results in wider stop (click to enlarge)
Setting a stop further away in times of higher volatility and
closer when volatility is low, allows the trader to react to changing
market conditions and optimize his reward:risk ratio and risk profile.
A maximum position of 2%
Although the stop loss size (in point distance) changed for every
trade, the risked always stayed the same. The maximum allowed risk
(position size) on any one trade was 2% of the current total account
balance. The table below shows two examples of how the turtle traders
would adjust their stop and position size based on volatility.
Volatility
Entry Price
Stop Loss Price
Stop Distance
Account Size
Risk per trade
Contracts to buy
LOW
$ 100
$ 96
$ 4
$ 100,000
2% ($ 2,000)
500
HIGH
$ 100
$ 90
$ 10
$ 100,000
2% ($2,000)
200
The numbers are for illustration purposes only
Although the risk is identical (2% or $ 2,000), the turtle traders
have to buy more contracts during lower volatility because the stop loss
is set closer.
Always determine the stop loss distance first. Most amateur traders
start by evaluating how many contracts they want to buy and then set
their stop loss order so they can achieve a random risk goal. Never
start by thinking how many contracts you want to buy/sell before you
know your stop loss.
Correlations and risk
If the turtle traders want to enter two trades in different
instruments, they had to look at the correlation between the two markets
first.
A quick reminder: correlations describe how “similar” two
markets move. A positive correlation means that the two markets move in
the same direction and a negative correlation means that they move in
opposite directions.
High positive correlation. Two markets move together (click to enlarge)
Negative correlation. Two markets move in opposite directions (click to enlarge)
The two charts above show two different scenarios. On the left, you
see two price charts with a very high positive correlation (the two
graphs almost move identical). On the right, you see two charts with a
negative correlation (they move in opposite directions).
A trader who enters two trades in the same direction (two buy or two
sell trades) on positively correlated markets increases his risk because
it is more likely that the two trades end up the same. A trader who
enters two trades in different directions (one buy and one sell trade)in
positively correlated instruments will probably (not guaranteed) not
have the same result.
(click to enlarge)
When trading positively correlated markets, your risk increases. When
trading negatively correlated markets, you can lower your risk.
The turtle traders did not come up with this strategy, but it has
been used by professionals as long as trading exists. It is the
irrefutable law of how financial markets work and understanding
correlations is of great importance.
Adding to a winner
The turtle traders usually did not enter the full position size on
the first entry. Remember that they were allowed to use 2% per trade,
but they usually split their order across multiple entries and added to a
winner. Their first position would be 0.5% and after the trade has
moved into profits, they would add another 0.5%. They would keep adding
to their trade until they reached the maximum of 2%. At the same time,
they moved their stop loss behind price to protect their position.
The advantages of adding to a winning trade:
You limit your losses. The turtle traders’ strategy
was a breakout and trend-following strategy. On a false breakout, when
price immediately reversed on them, they would usually only have a very
small position and not yet have scaled in. Thus, the loss they take is
only a small portion of the 2% maximum risk.
You can catch large winning trades and protect your position. You would only reach your full position size during high momentum breakouts and once you had reached the maximum exposure of 2%, the initial stop loss orders would already have locked in some profits.
You have to minimize your losses and try to preserve capital
for those very few instances where you can make a lot in a very short
period of time. What you can’t afford to do is throw away your capital
on suboptimal trades. – Richard Dennis
Adjusting position size during losing streaks
Dennis and Eckhardt understood that the most important thing during a
losing streak is not how fast you can recoup your losses, but the
degree to which you can limit your losses. Their rule to limit drawdowns
during losing streaks shows this principle:
If your account drops 10%, you then trade as if your account has lost
20%. If you lost $10,000 on a $100,000 account, you then trade as if
your account only has left $80,0000.
This means that even though your account is now $90,000 and your 2%
would be $1,800, you only trade as if your account is $80,000 with a
maximum risk of $1,600. This strategy will greatly reduce the losses
once a trader enters a significant losing streak and it takes away a lot
of emotional pressure as well.
This sounds like a lot of rules for just money management and position sizing. Let’s briefly compare that to the turtle traders’ rules for trade entries:
You enter a trade when price breaks above its 20-day range
You enter a trade when price breaks above its 55-day range
You are right, not a lot of trade entry rules, although there were
small variations and exceptions to the rules. The point is that the
professionals understand that entry rules only have very little
importance and that the most important cornerstone of any trading
strategy is position sizing and risk management. This is a major reason
why so many amateur traders struggle; they focus all their energy and
spend all their time on the least important factor.
1. How much time in a day do you have devote to trading?
>2 hours at night
2. When you are trading, how many distractions do you expect to have?
>none
3. How much time do you expect to devote to developing your trading
system, to doing your personal psychological work, and to working on
your business plan for trading?
>Developing system - every weekend
Personal psychology - everyday
Business Plan - monthly
4. What are your computer skills? What skills do you need before you begin this trading venture?
>Excel Spreadsheet
5. What do you know about statistics? What you need to know in statistics? >Multivariate statistics. Market Hypothesis testing.
6. How would you rate your market knowledge?
>Medium in Chart reading
>Poor in Risk Management
7. What are your psychological strengths and weaknesses in terms of personal discipline?
>Might not follow stop loss signal.
Too anxious and impatient when there is no entry or exit signals for consecutive few days.
8. Do you tend to get compulsive (caught up in the excitement of
trading)? Or do you have emotional issues that constantly crop up, such
as fear or anger?
>Yes & Impatience.
9. What do you need to learn, accomplish or solve prior to beginning trading? How will you do that?
>I need to learn to discipline myself so that I do not get impatience
and enter/exit unnecessarily. Also need to have a trading system, risk
management system, recording and evaluation systems being mapped out.
PART 2 : Defining Objectives
1. What is your advantage or edge in trading? What is the particular concept that you are trading that gives you an advantage?
>Reversals
2. How much money can you afford to lose? How much risk can you afford to take on each trade?
>$10k in total. Risk of 2% per trade (as per industry standard).
3. How much money do you need to make each year? Do you need to live off that money?
> Min. 30%. No.
4. Do you understand that you may have long losing streaks continuously (eg. 10 losses in a row)?
>Yes
5. Do you have the time to trade short term?
>Yes.
6. How much social contact do you need?
>None
7. Can you work by yourselves day after day? How much do other people influence you?
>Yes. None.
8. How much do you expect to make each year as a percentage of your trading capital?
> Min 30% of trading capital
9. What risk level are you willing to tolerate in order to achieve that?
>Max 10% of trading capital
10. How will you know your system is working/not working? What do you
expect from your system in various type of markets
(trending/Sideways/High Volatile/Low Volatile)?
>Conduct system test run once per quarter.
> My current system (Reversals) - Sideways market/ volatility??
PART 3 : Trading Ideas
1. What kind of market do you want to trade? Is it appropriate to specialise?
> Need to specialise.
Type of market I want to trade :
- Volatile Sideways ???
- Involatile Trending ???
- Reversal
- High Liquidity
2. Do you want any conditions to setup before you enter the market? What are they?
> Check psychology - No distraction
> Chart - Trendlines, Support/Resistance, VSA, Candlesticks,Indicators
> Risk Management
>Exit strategy
3. How important do you think entry is?
>Very important (even though Van K Tharp thinks it's not important)
4. What is your stop loss plan? If you have been stopped out, how are you going to enter the market again?
> Initial stop loss - At support
> Trailing stop loss - At support of second entry
> Exit stop loss - reversals (candlestick & indicators)
5. How do you plan to take profits?
>Possible methods :
Reversal stops
Trailing stops Technical stops ???
Price objectives
6. What is your plan in terms of position sizing?
> Pyramid
NO TRADING
1. No trading when STI is going to go downtrend.
2. Concentration is poor.
3. No time to monitor for the next few days
NO BUYING
1. When testing out new idea.
BUY only WHEN
1. Hit support
2. Shakedown in low volume (contra)
3. Shakedown in high volume when going into previous old trading area (contra)
4. ADX below 30
5. RSI / Stoc divergence
SELL when
1. Extreme high volume buying in same day
2. MFI hit above 80%
3. RSI / Stoc divergence
4. Unsure of direction
5. No movement at T+5
TRADING PERIOD
9.00 - 10.00am for Shakeout /Upthrust play
4.00 - 5.00pm for Breakout play
TRADING WATCHLIST
Max 10 at a time
ENTERING TRADE
Max 4 at a time (due to POEMS chart limitation)
