The Turtle Trading System is a well-known trend-following strategy that traders use to capitalize on sustained market momentum. Developed in the early 1980s by Richard Dennis and William Eckhardt, the system was part of an experiment to determine if trading success could be taught. The experiment involved training a group of novices, known as “Turtles,” in a set of trading rules and observing their performance. The Turtles became a legendary trading experiment, collectively earning over $100 million in four years.
History and Background
The Turtle Traders experiment originated from a disagreement between Richard Dennis, a successful commodities trader, and William Eckhardt, who believed that genetics played a crucial role in trading success.
A picture of Richard Dennis in 1986
To resolve their debate, Dennis trained 14 inexperienced traders and provided them with a set of rules to follow. Those who performed well were given $1 million of Dennis’ own money to manage, proving that a simple set of rules could turn individuals with little or no trading experience into successful traders.
Key Principles and Philosophy Behind the System
The Turtle Trading System is based on the following key principles:
1. Trend Following: The system is designed to identify and follow long-term trends in the market.
2. Position Sizing: The system emphasizes volatility-based position sizing methods to determine the appropriate size of a trade.
3. Pyramiding: The Turtles used the pyramiding technique to maximize profits on winning trades by adding more positions as the trade moved in their favor.
4. Risk Management: The system uses stop-loss orders to limit potential losses on trades and preserve capital.
The Turtle Trading System also involves specific entry and exit rules, as well as tactics for dealing with fast-moving markets and using limit orders. The system can be automated, allowing traders to use software programs to implement the rules and principles automatically, saving time and reducing the potential for human error.
While the Turtle Trading System was highly successful during the 1980s, its performance in recent years has been mixed. Some studies have found that the system’s returns were flat between 1996 and 2009, while others suggest that small changes to the system could yield positive results. Despite its potential drawbacks, the Turtle Trading System remains an influential and widely studied trading strategy.
Components of the Turtle Trading System
The Turtle Trading System is designed to capture long-term market trends, which means it may not always capitalize on short-term trading opportunities. The Turtles employed two systems, System One (S1) and System Two (S2), to manage their entries and exits. S1 focused on shorter-term breakouts, while S2 targeted longer-term breakouts. This approach allowed them to distinguish between primary and secondary trends, ensuring they traded in the direction of the overall market momentum.
The system also relies on trading channels to identify breakouts and trends. Specifically, it uses Donchian Channels, which plot the highest price from the previous x-number of trading days and the lowest price from the previous x-number of trading days as a channel. When the price breaks above the upper channel, it signals a potential long entry, and when it breaks below the lower channel, it indicates a potential short entry. This method helps traders identify and follow trends while determining appropriate entry and exit points[2].
An Image of the Turtle Trading System
Volatility-based Stop Loss: The ATR-based stop-loss mechanism for managing risk
The Turtles used a volatility-based stop-loss mechanism to manage risk in their trading system. They utilized the Average True Range (ATR) indicator to determine the size of their stop loss based on the asset’s volatility. This approach ensured that each trade had an appropriate stop loss level, which would limit potential losses and preserve capital. By using a volatility-based stop loss, the Turtle Trading System effectively managed risk and adapted to changing market conditions.
Adapting the Turtle Trading System to Currency Markets
A crucial step in this adaptation is selecting suitable currency pairs for the strategy. The original Turtles preferred liquid markets and major currency pairs like the Swiss Franc, Deutschmark, British Pound, French Franc, Japanese Yen, and Canadian Dollar. To increase the chances of success, traders should focus on liquid currency pairs, including commodity currencies paired with the USD.
Several factors need consideration when trading Forex with the Turtle Trading System. Firstly, the timeframe is crucial; the original Turtles traded on daily timeframes to pinpoint the perfect entry. Thus, it’s essential to use similar timeframes in Forex to capture long-term trends effectively. Secondly, risk management is a key principle in the Turtle Trading System, achieved through position sizing and stop-loss orders. Applying these risk management principles in currency markets is vital for effective trading. Lastly, the Turtle Trading System uses volatility-based position sizing and stop-loss mechanisms. Forex traders should consider the unique volatility characteristics of currency pairs when using the system.
By understanding the distinct traits of currency markets and making appropriate adjustments, traders can potentially benefit from the Turtle Trading System’s trend-following principles in the Forex market.
Implementing the Turtle Trading System in Currency Trading
Setting up trading rules and parameters:
To implement the Turtle Trading System in currency trading, you need to establish trading rules and parameters. These include selecting suitable currency pairs, using appropriate timeframes (such as daily), and applying the Turtle Trading principles, such as trend following, position sizing, and risk management.
Executing trades based on the strategy:
Once the trading rules and parameters are set, execute trades based on the strategy. For example, enter long positions when the price breaks above the 20-day high and exit when the price falls below the 10-day low. Use stop-loss orders based on the Average True Range (ATR) to manage risk and preserve capital.
Keeping track of trade records and performance metrics:
Maintain a record of your trades and monitor performance metrics to evaluate the effectiveness of the Turtle Trading System in currency markets.
A backtest of the Turtle trading system
This will help you identify areas for improvement and make necessary adjustments to the strategy. Use trading software or platforms that offer built-in performance reports and analytics to track your progress.
Conclusion
The Turtle Trading System is a renowned trend-following strategy that was developed in the 1980s by Richard Dennis and William Eckhardt. It focuses on identifying and following long-term market trends, using specific entry and exit rules, position sizing, and risk management principles. The system has been historically successful in various markets, including commodities and currencies.
When adapting the Turtle Trading System to currency markets, traders should consider the unique characteristics of the Forex market, choose suitable currency pairs, and apply the key principles of the system. Some key takeaways for traders interested in applying the Turtle Trading System to currency markets include understanding the importance of trend identification, using a systematic approach to determine trade sizes based on risk tolerance, and following specific guidelines for entering and exiting trades. By doing so, traders can potentially benefit from the strategy’s trend-following principles in the currency market.
