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The Turtle Trading Strategy: A Comprehensive Guide
The Turtle Trading Strategy is a well-known trend-following system that originated in the 1980s. It’s often regarded as one of the most successful experiments in trading history, demonstrating how discipline and a simple strategy can outperform complex financial models. In this article, we will explore the background of the Turtle Trading Strategy, its core principles, and how to set it up and implement it in the modern markets.
Background of the Turtle Trading Strategy
The Turtle Trading Strategy was developed by legendary traders Richard Dennis and Bill Eckhardt. In the early 1980s, the two had a debate over whether great traders were born or made. Dennis believed that successful trading could be taught, while Eckhardt was skeptical, thinking that innate talent was the key. To settle the argument, Dennis conducted an experiment.
He recruited 14 individuals from various backgrounds, calling them the “Turtles.” They were taught a trend-following strategy over two weeks, focusing on technical indicators rather than fundamental analysis. These Turtles went on to collectively make over $100 million in profits within a few years, proving Dennis’ point that disciplined execution of a well-defined strategy could lead to remarkable success.
Core Principles of the Turtle Trading Strategy
At its heart, the Turtle Trading Strategy is a trend-following system. It aims to capture large market movements by entering positions when a strong trend is identified and holding those positions until the trend reverses. The strategy is simple in concept but requires strict adherence to a set of rules.
The key principles of the strategy are:
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Position Sizing: Trades are sized based on the volatility of the market, which helps manage risk.
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Entry and Exit Rules: Positions are entered based on breakouts from recent price ranges, and they are exited when the trend starts to reverse.
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Risk Management: Strict stop-losses are used to protect against significant losses, with risk always controlled on every trade.
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Diversification: The strategy is applied across multiple markets, including commodities, stocks, currencies, and bonds, to capture trends wherever they occur.
Setting Up the Turtle Trading Strategy
Below is a detailed step-by-step guide to setting up and implementing the Turtle Trading Strategy.
1. Market Selection
The Turtle Trading Strategy is a multi-market approach. You should select markets with sufficient liquidity and volatility to allow for meaningful price movements. Some common markets include:
- Commodities (e.g., gold, oil, corn)
- Currencies (e.g., EUR/USD, JPY/USD)
- Indices (e.g., S&P 500, NASDAQ)
- Bonds (e.g., U.S. Treasury bonds)
2. Position Sizing: Volatility-Based
One of the critical elements of the Turtle system is position sizing based on volatility. The more volatile a market is, the smaller your position should be, and vice versa. This is done by calculating N, a measure of market volatility.
Formula for N:
N = (19-day exponential moving average of True Range)
Where the True Range is defined as the greatest of the following:
- Current high minus current low
- Current high minus previous close
- Current low minus previous close
Once you have N, the position size for any given trade is determined by dividing 1% of the portfolio’s value by N. This ensures that more volatile markets receive smaller allocations and less volatile markets receive larger ones.
Example:
If the portfolio size is $1,000,000 and N is 0.5, the trade size would be:
Trade Size = (1% of $1,000,000) / 0.5 = $10,000 / 0.5 = $20,000
3. Entry Rules: Breakouts
Turtles used two primary breakout systems for trade entries:
Short-Term Breakout: Enter a position when the price breaks above the 20-day high (for longs) or below the 20-day low (for shorts).
Long-Term Breakout: Enter when the price breaks above the 55-day high (for longs) or below the 55-day low (for shorts).
To prevent excessive trading, the Turtles did not take trades if the breakout occurred within the last 20 days (this prevents false signals during trend consolidations).
Example:
If the current price breaks above the highest price seen over the last 20 days, this signals a buy.
4. Exit Rules: Trend Reversals
Once in a trade, the Turtles used the opposite breakout to exit. For example, if they had entered a position on a 20-day breakout, they would exit when the price hit the 10-day low (for a long trade) or the 10-day high (for a short trade).
For positions entered based on the 55-day breakout, exits were made at the 20-day low (for longs) or the 20-day high (for shorts).
5. Risk Management: Stop-Losses
A key element of the strategy is risk management. Turtles limited risk on any trade to 2% of their portfolio. This was achieved by placing stop-losses based on N. The stop-loss was typically placed at 2N away from the entry point.
Example:
If you enter a long position with N = 0.5, and the entry price is $100, the stop-loss is placed at $100 - 2 × 0.5 = $99. This controls the potential loss in case the trade does not go as expected.
6. Diversification
The Turtles applied their system to multiple markets simultaneously, ensuring that they captured trends wherever they occurred. A well-diversified portfolio helps balance the risks across different asset classes.
7. Scaling into Positions
The Turtles often scaled into their positions by adding additional units as the trend continued in their favor. For example, after a trade moved 0.5N in the desired direction, another unit could be added, with the stop-loss adjusted accordingly.
Conclusion
The Turtle Trading Strategy is a classic trend-following system that has proven its effectiveness over decades. Its simplicity is its strength, but the real key to success lies in strict discipline and risk management. By following the core principles of volatility-based position sizing, breakout entries, trend-following exits, and controlled risk, traders can potentially capture large market trends with a well-defined edge.
This system, while developed in the 1980s, still offers valuable lessons for modern traders about the importance of strategy, discipline, and risk management in financial markets.
Additional Reading
- John Hill, George Pruitt - The Ultimate Trading Guide - PDFCOFFEE.COM
- “The Complete TurtleTrader” by Michael Covel
- “Way of the Turtle” by Curtis Faith
- https://youtu.be/sqdU7wbjNpg
- https://tradesanta.com/blog/turtle-trading-in-the-crypto-market-a-viable-strategy
By following the guidelines outlined here, you can start experimenting with the Turtle Trading Strategy and test its performance in different market conditions.
