, or a large profit. Theconfidence, consistency, and discipline afforded by a thoroughly testedmechanical system are the key to many of the most profitable traders’ success.The Turtle Trading System was a Complete Trading System. Its rulescovered every aspect of trading, and left no decisions to the subjective whimsof the trader. It had every component of a Complete Trading System.
The Components of a Complete SystemA Complete Trading System covers each of the decisions required for successful trading:••••••
Markets — What to buy or sellPosition Sizing — How much to buy or sellEntries — When to buy or sellStops — When to get out of a losing positionExits — When to get out of a winning positionTactics — How to buy or sell
Markets — What to buy or sellThe first decision is what to buy and sell, or essentially, what markets totrade. If you trade too few markets you greatly reduce your chances ofgetting aboard a trend. At the same time, you don’t want to trade marketsthat have too low a trading volume, or that don’t trend well.Position Sizing — How much to buy or sellThe decision about how much to buy or sell is absolutely fundamental, andyet is often glossed over or handled improperly by most traders.How much to buy or sell affects both diversification and money management. Diversification is an attempt to spread risk across many instruments, and to increase the opportunity for profit by increasing the opportunities for catching successful trades. Proper diversification requires makingsimilar, if not identical bets on many different instruments. Money management is really about controlling risk by not betting so much that you runout of money before the good trends come.
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How much to buy or sell is the single most important aspect of trading.Most beginning traders risk far too much on each trade, and greatly increasetheir chances of going bust, even if they have an otherwise valid trading style.Entries — When to buy or sellThe decision of when to buy or sell is often called the entry decision. Automated systems generate entry signals which define the exact price and market conditions to enter the market, whether by buying or selling.Stops — When to get out of a losing positionTraders who do not cut their losses will not be successful in the long term.The most important thing about cutting your losses is to predefine the pointwhere you will get out before you enter a position.Exits — When to get out of a winning positionMany “trading systems” that are sold as complete trading systems do notspecifically address the exit of winning positions. Yet the question of whento get out of a winning position is crucial to the profitability of the system.Any trading system that does not address the exit of winning positions isnot a Complete Trading System.Tactics — How to buy or sellOnce a signal has been generated, tactical considerations regarding themechanics of execution become important. This is especially true for largeraccounts, where the entry and exit of positions can result in significantadverse price movement, or market impact.
SummaryUsing a mechanical system is the best way to consistently make moneytrading. If you know that your system makes money over the long run, it iseasier to take the signals and follow the system during periods of losses. Ifyou rely on your own judgment, during trading you may find that you arefearful just when you should be courageous, or courageous when you shouldbe fearful.If you have a profitable mechanical trading system, and you follow itreligiously, then your trading will be profitable, and the system will helpyou survive the emotional struggles that inevitably result from a long seriesof losses, or large profits.The trading system that was used by the Turtles was a Complete TradingSystem. This was a major factor in our success. Our system made it easierto trade consistently, and successfully, because it did not leave importantdecisions to the discretion of the trader.
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Chapter 2Markets: What the Turtles TradedThe Turtles traded liquid futures that traded on U.S. exchangesin Chicago and New York.The Turtles were futures traders, at the time more popularly called commodities traders. We traded futures contracts on the most popular U.S. commodities exchanges.Since we were trading millions of dollars, we could not trade marketsthat only traded a few hundred contracts per day because that would meanthat the orders we generated would move the market so much that it wouldbe too difficult to enter and exit positions without taking large losses. TheTurtles traded only the most liquid markets.In general, the Turtles traded all liquid U.S. markets except the grainsand the meats. Since Richard Dennis was already trading the full positionlimits for his own account, he could not permit us to trade grains for himwithout exceeding the exchange’s position limits.We did not trade the meats because of a corruption problem with thefloor traders in the meat pits. Some years after the Turtles disbanded, theFBI conducted a major sting operation in the Chicago meat pits and indictedmany traders for price manipulation and other forms of corruption.The following is a list of the futures markets traded by the Turtles:Chicago Board of Trade 30 Year U.S. Treasury Bond 10 Year U.S. Treasury NoteNew York Coffee Cocoa and Sugar Exchange Coffee Cocoa Sugar CottonChicago Mercantile Exchange Swiss Franc Deutschmark British Pound French Franc Japanese Yen Canadian Dollar S&P 500 Stock Index Eurodollar 90 Day U.S. Treasury Bill
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Comex Gold Silver CopperNew York Mercantile Exchange Crude Oil Heating Oil Unleaded GasThe Turtles were given the discretion of not trading any of the commoditieson the list. However, if a trader chose not to trade a particular market, thenhe was not to trade that market at all. We were not supposed to trade marketsinconsistently.
Chapter 3Position SizingThe Turtles used a volatility-based constant percentage risk positionsizing algorithm.Position sizing is one of the most important but least understood componentsof any trading system. The Turtles used a position sizing algorithm that wasvery advanced for its day, because it normalized the dollar volatility of aposition by adjusting the position size based on the dollar volatility of themarket. This meant that a given position would tend to move up or downin a given day about the same amount in dollar terms (when compared topositions in other markets), irrespective of the underlying volatility of theparticular market.This is true because positions in markets that moved up and down alarge amount per contract would have an offsetting smaller number of contracts than positions in markets that had lower volatility.This volatility normalization is very important because it means thatdifferent trades in different markets tend to have the same chance for aparticular dollar loss or a particular dollar gain. This increased the effectiveness of the diversification of trading across many markets.Even if the volatility of a given market was lower, any significant trendwould result in a sizeable win because the Turtles would have held morecontracts of that lower volatility commodity.
Volatility — The Meaning of NThe Turtles used a concept that Richard Dennis and Bill Eckhardt called Nto represent the underlying volatility of a particular market. N is simply the20-day exponential moving average of the True Range, which is now more
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commonly known as the ATR. Conceptually, N represents the average rangein price movement that a particular market makes in a single day, accountingfor opening gaps. N was measured in the same points as the underlyingcontract.To compute the daily true range:True Range = Maximum (H-L, H-PDC, PDC-L)where:H= Current HighL= Current LowPDC = Previous Day’s CloseTo compute N use the following formula:N = (19 · PDN + TR )20where:PDN = Previous Day’s NTR = Current Day’s True RangeSince this formula requires a previous day’s N value, you must start with a20-day simple average of the True Range for the initial calculation.
Dollar Volatility AdjustmentThe first step in determining the position size was to determine the dollarvolatility represented by the underlying market’s price volatility (defined byits N).This sounds more complicated than it is. It is determined using thesimple formula:Dollar Volatility = N x Dollars per Point
Volatility Adjusted Position UnitsThe Turtles built positions in pieces which we called Units. Units were sizedso that 1 N represented 1% of the account equity.Thus, a unit for a given market or commodity can be calculated usingthe following formula:Unit =
Account of 1%Market Dollar Volatilityy
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orUnit =
Account of 1%N × Dollars per Point
ExamplesHeating Oil HO03H:Consider the following prices, True Range, and N values for March 2003Heating Oil:Date
High
Low
Close
True Range
N
11/1/200211/4/200211/5/200211/6/200211/7/200211/8/200211/11/200211/12/200211/13/200211/14/200211/15/200211/18/200211/19/200211/20/200211/21/200211/22/200211/25/200211/26/200211/27/200212/2/200212/3/200212/4/2002
0.72200.71700.70990.69300.69600.68200.68200.67950.67600.66500.67010.69650.70650.71150.71680.72650.72650.71840.72800.73750.74470.7420
0.71240.70730.69230.68000.67360.67060.67100.67200.65500.65850.66200.67500.69440.69440.71000.71200.70980.71100.72000.72270.73100.7140
0.71240.70730.69230.68380.67360.67060.67100.67440.66160.66270.67010.69650.69440.70870.71240.72650.70980.71840.72280.73590.73890.7162
0.00960.00970.01760.01300.02240.01140.01140.00850.02100.00650.00810.02640.01210.01710.00810.01450.01670.00860.00960.01480.01370.0280
0.01340.01320.01340.01340.01390.01370.01360.01340.01380.01340.01310.01380.01370.01390.01360.01360.01380.01350.01330.01340.01340.0141
The unit size for the 6th of December, 2002 (using the N value of 0.0141 fromthe 4th of December), is as follows:Heating OilN = 0.0141Account Size = $1,000,000Dollars per Point = 42,000(42,000 gallon contracts with price quoted in dollars)Size Unit =
0.01·$1, 000 , 000= 16.880.0141 × 42 , 000
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Since it isn’t possible to trade partial contracts, this would be truncated toan even 16 contracts.You might ask: “How often is it necessary to compute the values for Nand the Unit Size?” The Turtles were provided with a Unit size sheet onMonday of each week that listed the N, and the Unit size in contracts foreach of the futures that we traded.
The Importance of Position SizingDiversification is an attempt to spread risk across many instruments and toincrease the opportunity for profit by increasing the opportunities for catching successful trades. To properly diversify requires making similar if notidentical bets on many different instruments.The Turtle System used market volatility to measure the risk involvedin each market. We then used this risk measurement to build positions inincrements that represented a constant amount of risk (or volatility). Thisenhanced the benefits of diversification, and increased the likelihood thatwinning trades would offset losing trades.Note that this diversification is much harder to achieve when usinginsufficient trading capital. Consider the above example if a $100,000 accounthad been used. The unit size would have been a single contract, since 1.688truncates to 1. For smaller accounts, the granularity of adjustment is toolarge, and this greatly reduces the effectiveness of diversification.
Units As a Measure of RiskSince the Turtles used the Unit as the base measure for position size, andsince those units were volatility risk adjusted, the Unit was a measure ofboth the risk of a position, and of the entire portfolio of positions.The Turtles were given risk management rules that limited the numberof Units that we could maintain at any given time, on four different levels.In essence, these rules controlled the total risk that a trader could carry, andthese limits minimized losses during prolonged losing periods, as well asduring extraordinary price movements.An example of an extraordinary price movement was the day after theOctober 1987 stock market crash. The U.S. Federal Reserve lowered interestrates by several percentage points overnight to boost the confidence of thestock market and the country. The Turtles were loaded long in interest ratefutures: Eurodollars, TBills and Bonds. The losses the following day wereenormous. In some cases, 20% to 40% of account equity was lost in a singleday. But these losses would have been correspondingly higher without themaximum position limits.
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The limits were:Level1234
TypeSingle MarketClosely Correlated MarketsLoosely Correlated MarketsSingle Direction – Long or Short
Maximum Units4 Units6 Units10 Units12 Units
Single Markets — A maximum of four Units per market.Closely Correlated Markets — For markets that were closely correlatedthere could be a maximum of 6 Units in one particular direction (i.e. 6 longunits or 6 short units). Closely correlated markets include: heating oil andcrude oil; gold and silver; Swiss franc and Deutschmark; TBill and Eurodollar, etc.Loosely Correlated Markets — For loosely correlated markets, therecould be a maximum of 10 Units in one particular direction. Loosely correlated markets included: gold and copper; silver and copper, and many graincombinations that the Turtles did not trade because of positions limits.Single Direction — The maximum number of total Units in one directionlong or short was 12 Units. Thus, one could theoretically have had 12 Unitslong and 12 Units short at the same time.The Turtles used the term loaded to represent having the maximumpermitted number of Units for a given risk level. Thus, “loaded in yen”meant having the maximum 4 units of Japanese Yen contracts. Completelyloaded meant having 12 Units, etc.
Adjusting Trading SizeThere will be times when the market does not trend for many months. Duringthese times, it is possible to lose a significant percentage of the equity of theaccount.After large winning trades close out, one might want to increase the sizeof the equity used to compute position size.The Turtles did not trade normal accounts with a running balance basedon the initial equity. We were given notional accounts with a starting equityof zero and a specific account size. For example, many Turtles received anotional account size of $1,000,000 when we first started trading in February1983. This account size was then adjusted each year at the beginning of theyear. It was adjusted up or down depending on the success of the trader asmeasured subjectively by Rich. The increase/decrease typically representedsomething close to the addition of the gains or losses that were made in theaccount during the preceding year.
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The Turtles were instructed to decrease the size of the notional accountby 20% each time we went down 10% of the original account. So if a Turtletrading a $1,000,000 account was ever was down 10%, or $100,000, we wouldthen begin trading as if we had a $800,000 account until such time as wereached the yearly starting equity. If we lost another 10% (10% of $800,000or $80,000 for a total loss of $180,000) we were to reduce the account size byanother 20% for a notional account size of $640,000.There are other, perhaps better strategies for reducing or increasingequity as the account goes up or down. These are simply the rules that theTurtles used.
Chapter 4EntriesThe Turtles used two related system entries, each based on Donchian’schannel breakout system.The typical trader thinks mostly in terms of the entry signals when thinkingabout a particular trading system. They believe that the entry is the mostimportant aspect of any trading system.They might be very surprised to find that the Turtles used a very simpleentry system based on the Channel Breakout systems taught by RichardDonchian.The Turtles were given rules for two different but related breakout systems we called System 1 and System 2. We were given full discretion toallocate as much of our equity to either system as we wanted. Some of uschose to trade all our equity using System 2, some chose to use a 50% System1, 50% System 2 split, while others chose different mixes.System 1 — A shorter-term system based on a 20-day breakoutSystem 2 — A simpler long-term system based on a 55-day breakout.
BreakoutsA breakout is defined as the price exceeding the high or low of a particularnumber of days. Thus a 20-day breakout would be defined as exceeding thehigh or low of the preceding 20 days.Turtles always traded at the breakout when it was exceeded during theday, and did not wait until the daily close or the open of the following day.In the case of opening gaps, the Turtles would enter positions on the openif a market opened through the price of the breakout.System 1 Entry — Turtles entered positions when the price exceeded bya single tick the high or low of the preceding 20 days. If the price exceeded
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the 20-day high, then the Turtles would buy one Unit to initiate a longposition in the corresponding commodity. If the price dropped one tick belowthe low of the last 20 days, the Turtles would sell one Unit to initiate a shortposition.System 1 breakout entry signals would be ignored if the last breakoutwould have resulted in a winning trade. Note: For the purposes of this test,the last breakout was considered the last breakout in the particular commodityirrespective of whether or not that particular breakout was actually taken, orwas skipped because of this rule. This breakout would be considered a losingbreakout if the price subsequent to the date of the breakout moved 2N againstthe position before a profitable 10-day exit occurred.The direction of the last breakout was irrelevant to this rule. Thus, a losinglong breakout or a losing short breakout would enable the subsequent newbreakout to be taken as a valid entry, regardless of its direction (long or short).However, in the event that a System 1 entry breakout was skippedbecause the previous trade had been a winner, an entry would be made atthe 55-day breakout to avoid missing major moves. This 55-day breakoutwas considered the Failsafe Breakout point.At any given point, if you were out of the market, there would alwaysbe some price which would trigger a short entry and another different andhigher price which would trigger a long entry. If the last breakout was aloser, then the entry signal would be closer to the current price (i.e., the 20day breakout), than if it had been a winner, in which case the entry signalwould likely be farther away, at the 55-day breakout.System 2 Entry — Entered when the price exceeded by a single tick thehigh or low of the preceding 55 days. If the price exceeded the 55-day high,then the Turtles would buy one Unit to initiate a long position in the corresponding commodity. If the price dropped one tick below the low of the last55 days, the Turtles would sell one Unit to initiate a short position.All breakouts for System 2 would be taken whether the previous breakout had been a winner or not.
Adding UnitsTurtles entered single Unit long positions at the breakouts and added to thosepositions at ½ N intervals following their initial entry. This ½ N interval wasbased on the actual fill price of the previous order. So if an initial breakoutorder slipped by ½ N, then the new order would be 1 full N past the breakoutto account for the ½ N slippage, plus the normal ½ N unit add interval.This would continue right up to the maximum permitted number ofunits. If the market moved quickly enough it was possible to add the maximum four Units in a single day.
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Example:GoldN = 2.5055-day breakout = 310First Unit addedSecond UnitThird UnitFourth UnitCrude OilN = 1.20
310.00310.00 + ½ 2.50 or 311.25311.25 + ½ 2.50 or 312.50312.50 + ½ 2.50 or 313.75
55-day breakout = 28.30First Unit addedSecond UnitThird UnitFourth Unit
28.3028.30 + ½ 1.20 or 28.9028.90 + ½ 1.20 or 29.5029.50 + ½ 1.20 or 30.10
ConsistencyThe Turtles were told to be very consistent in taking entry signals, becausemost of the profits in a given year might come from only two or three largewinning trades. If a signal was skipped or missed, this could greatly affectthe returns for the year.The Turtles with the best trading records consistently applied the entryrules. The Turtles with the worst records, and all those who were droppedfrom the program, failed to consistently enter positions when the rulesindicated.
Chapter 5StopsThe Turtles used N-based stops to avoid large losses in equity.There is an expression that, “There are old traders; and there are bold traders;but there are no old bold traders.” Traders that don’t use stops go broke.The Turtles always used stops.For most people, it is far easier to cling to the hope that a losing tradewill turn around than it is to simply get out of a losing position and admitthat the trade did not work out.
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Let us make one thing very clear. Getting out of a losing position isabsolutely critical. Traders who do not cut their losses will not be successfulin the long term. Almost all of the examples of trading that got out of controland jeopardized the health of the financial institution itself, such as Barings,Long-term Capital Management, and others, involved trades that wereallowed to develop into large losses because they were not cut short whenthey were small losses.The most important thing about cutting your losses is to have predefinedthe point where you will get out, before you enter a position. If the marketmoves to your price, you must get out, no exceptions, every single time.Wavering from this method will eventually result in disaster.
Turtle StopsHaving stops didn’t mean that the Turtles always had actual stop ordersplaced with the broker.Since the Turtles carried such large positions, we did not want to revealour positions or our trading strategies by placing stop orders with brokers.Instead, we were encouraged to have a particular price, which when hit,would cause us to exit our positions using either limit orders, or marketorders.These stops were non-negotiable exits. If a particular commodity tradedat the stop price, then the position was exited; each time, every time, withoutfail.
Stop PlacementThe Turtles placed their stops based on position risk. No trade could incurmore than 2% risk.Since 1 N of price movement represented 1% of Account Equity, themaximum stop that would allow 2% risk would be 2 N of price movement.Turtle stops were set at 2 N below the entry for long positions, and 2 Nabove the entry for short positions.In order to keep total position risk at a minimum, if additional unitswere added, the stops for earlier units were raised by ½ N. This generallymeant that all the stops for the entire position would be placed at 2 N fromthe most recently added unit. However, in cases where later units wereplaced at larger spacing either because of fast markets causing skid, orbecause of opening gaps, there would be differences in the stops.
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For example:Crude OilN = 1.2055-day breakout = 28.30First Unit
Entry Price28.30
Stop25.90
First UnitSecond Unit
Entry Price28.3028.90
Stop26.5026.50
First UnitSecond UnitThird Unit
Entry Price28.3028.9029.50
Stop27.1027.1027.10
First UnitSecond UnitThird UnitFourth Unit
Entry Price28.3028.9029.5030.10
Stop27.7027.7027.7027.70
Case where fourth unit was added at a higher price because the marketopened gappingup to 30.80:First UnitSecond UnitThird UnitFourth Unit
Entry Price28.3028.9029.5030.80
Stop27.7027.7027.7028.40
Alternate Stop Strategy — The WhipsawThe Turtles were told of an alternate stop strategy that resulted in betterprofitability, but that was harder to execute because it incurred many morelosses, which resulted in a lower win/loss ratio. This strategy was called theWhipsaw.Instead of taking a 2% risk on each trade, the stops were placed at ½ Nfor ½% account risk. If a given Unit was stopped out, the Unit would bere-entered if the market reached the original entry price. A few Turtles tradedthis method with good success.The Whipsaw also had the added benefit of not requiring the movementof stops for earlier Units as new Units were added, since the total risk wouldnever exceed 2% at the maximum four Units.
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For example, using Whipsaw stops, the Crude Oil entry stops would be:Crude OilN = 1.2055-day breakout = 28.30First Unit
Entry Price28.30
Stop27.70
First UnitSecond Unit
Entry Price28.3028.90
Stop27.7028.30
First UnitSecond UnitThird Unit
Entry Price28.3028.9029.50
Stop27.7028.3028.90
First UnitSecond UnitThird UnitFourth Unit
Entry Price28.3028.9029.5030.10
Stop27.7028.3028.9029.50
Benefits of the Turtle System StopsSince the Turtle’s stops were based on N, they adjusted to the volatility ofthe markets. More volatile markets would have wider stops, but they wouldalso have fewer contracts per Unit. This equalized the risk across all entriesand resulted in better diversification and a more robust risk management.
Chapter 6ExitsThe Turtles used breakout based exits for profitable positions.There is another old saying: “you can never go broke taking a profit.” TheTurtles would not agree with this statement. Getting out of winning positionstoo early, i.e., “taking a profit” too early, is one of the most common mistakeswhen trading trend following systems.Prices never go straight up; therefore it is necessary to let the prices goagainst you if you are going to ride a trend. Early in a trend this can oftenmean watching decent profits of 10% to 30% fade to a small loss. In themiddle of a trend, it might mean watching a profit of 80% to 100% drop by30% to 40%. The temptation to lighten the position to “lock in profits” canbe very great.
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The Turtles knew that where you took a profit could make the differencebetween winning and losing.The Turtle System enters on breakouts. Most breakouts do not result intrends. This means that most of