Would the Turtle Trading System Work Now?

Does turtle trading still work? During an economic downturn, many traders claim to have effective strategies to beat the system and still maximize profits. The turtle trading system is one of those systems. This article will explain the turtle trading system and how it worked for traders in the past. In addition, this article will demonstrate whether turtle trading could work in this volatile, coronavirus-addled market.

What is turtle trading?

When he met fellow trader, William Eckhardt, Dennis asserted that traders could be grown as easily as turtles on a farm that he saw in Singapore. (So, that’s the origin story of turtle trading’s name.) Eckhardt disagreed and thought that traders like Dennis had a natural gift. As a result of the disagreement, they decided to bet and see if Dennis could train random people to trade as well as him.

The turtle trading system started in 1983. ( Cue the Trading Places soundtrack.) Commodity trader Richard Dennis believed that anyone could be taught to trade to be an expert trader like him during the go-go time of trading in the 80’s. Richard became a legendary trader by the age of 26. During his time on the Chicago Mercantile Exchange, he built his net worth up to a staggering $100 million.

As Dennis noted in the book, Market Wizards, “I always say that you could publish my trading rules in the newspaper and no one would follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80% as good as what we taught our people. What they couldn’t do is give them the confidence to stick to those rules even when things are going bad.”

Who really started turtle trading?

While Dennis popularized turtle trading, Richard Donchian is the father of trend trading. Donchian started the system in the 1960’s with the following weekly trading rule:

“When the price moves above the high of two previous calendar weeks (the optimum number of weeks varies by commodity), cover your short positions and buy. When the price breaks below the low of the two previous calendar weeks, liquidate your long position and sell short.” 

Donchian had an earlier system of risk-averse trend trading, but Dennis perfected the turtle trading system.

How did Dennis find his turtles?

When Dennis started the turtle trading experiment, he placed an ad in The Wall Street Journal and found 13 “turtles” out of the thousands who applied. He tested them with a series of true-or-false questions. Five of them are below.

1. Others’ opinions of the markets are good to follow.
2. Trades in big money are made when one could get long at lows after a big downtrend.
3. An investor should know where to liquidate if a loss happens.
4. It is not helpful to watch every quote for an investor’s trading in the markets.
5. If an investor has $10,000 to risk, an investor should risk $2,500 on every trade.

Dennis chose investors to be turtle traders if they chose 2,4, 5 as true and 1 and 3 as false.

How else did Dennis attract his turtles?

Dennis placed a wide-ranging advertisement in the Wall Street Journal. The ad looked like this:

Richard J. Dennis of C&D Commodities is accepting applications for the position of Commodity Futures Trader to expand his established group of traders. Mr. Dennis and his associates will train a small group of applicants in his proprietary trading concepts. Successful candidates will then trade solely for Mr. Dennis: they will not be allowed to trade futures for themselves or others. Traders will be paid a percentage of their trading profits, and will be allowed a small draw. Prior experience in trading will be considered, but is not necessary. Applicants should send a brief resume with one sentence giving their reasons for applying to: C&D Commodities 141 W. Jackson, Suite 2313 Chicago, IL 60604 Attn: Dale Dellutri Applications must be received by October 1, 1984. No telephone calls will be accepted.

Who were the original turtle traders?

One of the original traders, Michael Cavallo, recalled the simplicity of the advertisement.

“The ad looked like the New York Yankees looking for a starting shortstop,”  said Cavallo.

Cavallo was one of the turtles from very diverse backgrounds. Dennis not only chose turtles from diverse backgrounds but also had diversity in gender as well. In addition to male traders, Dennis chose women to be turtles during a time when there were few women in trading. Cavallo was a commodities trader, but many of the traders were blue-collar workers like Jim DiMaria. DiMaria was grateful for the opportunity to learn from Dennis.

“That was enough to pay my grocery bills and I knew that was going to be secure,” DiMaria said.

Another turtle, Michael Shannon, was an unsuccessful broker until he became a turtle trader. He also noted that the traders learned a lot about discipline from Dennis.

“We’re purely technicians,” said Shannon. “Dennis taught us to be consistent, disciplined and execute the signals that come up and he was right.

What were the turtle trading system requirements?

After Dennis found his turtles, he gave $1 million of his own money to invest in their own accounts. Dennis placed an emphasis on mechanical trading over emotional trading. In addition to purely technical training, he also downplayed the importance of following financial reports on TV or in financial reports. ( No doubt, if Twitter was around, he would have disapproved of that, too.) Dennis put little faith in financial analysis.

‘You don’t get any profit from fundamental analysis. You get profit from buying and selling. So why stick with the appearance when you can go right to the reality of price?” said Dennis.

They could trade a maximum of 12 contracts a day for a month. There were six main turtle trading rules.

What were the turtle trading system rules?

1. Markets-What to buy or sell. Dennis told investors to invest in all major stocks, bonds, metals, commodities, and currencies. The turtles minimized the risk in multiple markets.
2. Position Sizing–How much to buy or sell. The turtles traded using a position-sized algorithm. The system looked at a 20-day exponential moving average true range. Turtles used that system to gauge the unpredictability of the markets. The turtles were trained to expand their positions when the market volatility was low. They traded in just 1% of the total equity of their accounts.
3. Entries–When to buy or sell. The turtles used two different entry strategies. The first entry system was a 20-day high or low. The second was a 55-day breakout entry strategy. Automatic systems create entry systems. Dennis told the traders to take all the signals on offer so they wouldn’t diminish the returns.
4. Stops-When to get out of a losing position. Dennis taught the turtles to stop losses whenever possible. A pivotal part of stop losses was determining them before the traders’ losses became too big.
5. Exits-When to get out of a winning position. There were two exit rules. The first rule had a 10-day low for short positions. The second rule had a 20-day/high low for long positions.
6. Tactics-How to buy or sell. Dennis taught traders about the psychological aspects or turtle trading. He also taught his turtles to exercise patience while placing orders during market volatility.

This TradingSim chart shows an example of trading through trend following.

Did turtle trading work when it first started?

Turtle trading had mixed results for the traders. One of the turtles, Richard Sands, claims the group netted $175 million using the system. Another trader, Michael Shannon, noted that despite the discipline they were taught, there was a lot of volatility.

“There are days when you take a significant hit and there are days when you make lots of money and of those the days when you make lots of money is probably the most psychologically damaging because suddenly you become fearless.”

How did trend following help turtle traders?

Shannon says he made about $3 million during his four years under Dennis’ tutelage.

Trend following was key to the traders. “The trend is your friend” is a mantra of turtle traders. That belief means that traders can follow trends of growth or value stocks to predict when the next bull or bear market will happen. Shannon noted the simplicity of trend trading.

“The market being in a trend is the main thing that eventually gets us in a trade. That is a pretty simple idea. Being consistent and making sure you do that all the time is probably more important than the particular characteristics you use to define the trend. Whatever method you use to enter trades, the most critical thing is that if there is a major trend, your approach should assure that you get in that trend,” said Shannon.

Even if the trends plummeted, traders still made a profit. Author Michael Covel, who wrote a must-read book about turtle trading, The Complete Turtle Trader, noted that turtle trading worked for most of the first traders.

“Once you recognize that market moves are random you simply need to put yourself in a position where you can capitalize on a move when it happens,” explained Covel.

“Seven out of ten will be dogs but three will make money and trend followers know that the winners will pay for the losses and give them a tidy profit,” added Covel.

What are the key tenets of trend trading?

Financial experts like Ali Hashemian noted that trend following is a systemic and methodical way to trade.

“Trend trading is a systematic approach to investing based on an asset’s current momentum. “A number of different trade signals can be used, and traditionally there are set rules and risk controls put into place when using this trading strategy. Simply put, this trading style captures gains by riding the upward or downward trend in an investment,” said Hashemian.

While many day traders may want to just use the system for stocks, Hashemian says most trend trading can mostly be for futures or commodities.

“Trend trading is commonly utilized by commodity traders,” said Hashemian. “Most often this trading style will include price calculations, moving averages, and take-profit or stop-loss provisions. Traders will use price movement and technical tools to determine trading signals.”

“Signals can often cause a trade too soon, and thus full potential gains are not always captured,” said Hashemian.

How can turtle traders identify a trend?

There are three types of primary trends that turtle traders can monitor to make trades.

1. Uptrends happen when stock prices increase. Turtle traders can go long on the stock as it’s rising.
2. Downtrends happen when a stock is falling. A trend trader can go short on a stock’s falling price.
3. Sideways trends happen when stocks are reaching neither higher or lower points. Turtle traders may not act on these trends, but day traders who want to jump on short-term market movements may want to move on sideways trends.

What system can turtle traders use to monitor stocks?

The turtle system used the Donchian Channel, a trend-following indicator. When turtle traders use the Donchian Channel , they usually set the indicator to monitor stocks over a 20-day price range. The original turtles traded during a 20-day breakout. However, they would only trade if there wasn’t a trend from the previous 20-day breakout. Turtles felt that if the previous trend couldn’t predict a breakout, the next breakout would produce a trend. Traders felt that they were minimizing risk if there wasn’t a previous breakout.

The 55-day Donchian channel indicator was added to catch more long-term emerging trends in the markets. Traders didn’t have to wait for a breakout to fail before making a trade. The Donchian Channel indicator is still used today by many traders.

This TradingSim chart shows how the Donchian Channel can be used for low-volatility stocks.

What are the top trend indicators for turtle trading?

The Donchian Channel is a moving average indicator. Moving average indicators are just one of the many trend indicators. Here are three of the most popular trend indicators to help turtles trade and track trends.

1. Moving average indicators find the average price of a stock over a timeframe, such as 20 or 55 days. It can predict past trends to help traders track trends better.

2. Average directional indexes track trends on a scale from 0 to 100. Values that range from 25 to 100 indicate a good trend for stocks. Values under 25 indicate weaker trends in stocks.

3. Relative strength index identifies momentum in overbought signals. They’re also used to identify momentum in prices. The relative strength index operates on a scale from 0 to 100. When a stock is overbought, the indicator is above 70. A stock is underbought if it’s under 30.

Why was the turtle trading system successful for some traders?

Trader Mike Martin noted the simplicity of the turtle trading system. Because the turtles only invested about 2% on a single trade, the turtles weren’t hastily risking too much of their money.

“The Turtle rules consisted therefore of a trend-following system of entries, exits and risk management. The model was built to catch the middle of the move and although Turtle trading results were volatile, the group was always managing risk. In essence, risk management was everything,” said Martin.

“The system is genius in its simplicity. A certain mathematical elegance can be found in its use of ATR [Average True Range] for entries, exits and position sizes and what you get out of each is up to you,” concludes Martin.

Shannon also believes that turtle trading was effective for him and other traders. However, the trading system didn’t work for all traders.

Why did the turtle trading system fail for some traders?

While some turtle traders made a profit when they were with Dennis, once they struck out on their own, the opposite happened.

“Interestingly the Turtles all made big money while they were working for Richard Dennis. However in 1988 when they went out on their own things it was another story,” says Covel.

“Many didn’t stick with it and fell apart. So even though there was a mechanical system that they all knew worked, at the end of the day other factors such as character issues became their downfall,” added Covel.

The overriding theme seems to be that systems may not change, but the market does. Financial analyst Mark Biernat noted that the turtle trading system may not work for two reasons. Ironically, the success of the program means it’s easier for other traders to copy. Copycats can alter the system and change a winning formula.

Biernet believes that the turtle trading system worked well for traders until 1996, when newer trading technology may have replaced the older trading systems of the 1980’s. He also asserts that the blue-chip stocks that were prominent in the 80’s like GM (NYSE:GM) are not as dominant as they used to be now.

This TradingSim chart shows an example of the blue-chip stocks the turtles traded.

Does turtle trading still work in today’s market?

As Al from TradingSim noted in an earlier article about trend trading, day traders may have to adjust their fast-paced trading schedule to move at, well, a turtle’s pace. While the slower pace may have worked with a more primitive trading system in the original turtle’s time, it may be different for more active traders. Busy traders tend to take action more quickly after monitoring the markets all day. However, turtle traders can watch trends develop for weeks, months, or even years.

While turtle trading worked in the 80’s, there are differing opinions about whether the turtle trading system would work now. In this era of Wall Street volatility, Dennis himself acknowledged that the turtle trading system could possibly work now. In an interview in 2018 before the current unpredictability, he noted could be harder to implement now because there was less volatility in the market two years ago.

“Well good luck with that one. The markets have changed a lot. What works is changing and is a bit of a problem, but what’s more of a problem is the lack of volatility. Volatility seems to me to have trailed off over the years intermittently. You know, I’d rather have the volatility back. I mean that’s a variable you can’t control, but I think that it’s more important than adjusting the system, although adjusting the system is important too,” said Dennis.

Original turtle trader says the system is evergreen

Jerry Parker, a disciple of Dennis and one of the original turtle investors, believes that turtle trading is timeless. He believes that the pivotal tenet of risk management when trading stocks and commodities is pivotal.

In an interview in 2018, Parker asserted that the main philosophy of turtle trading can be implemented during a bull market or a bear market.

“Well, I would say the basic philosophy hasn’t changed. You’re continuing to do research, finding robust systems, and that means systems with the least amount of parameters that tell you how to initiate, liquidate, or stay out of a trade. We’re always looking to build systems that are based on momentum or based on range dependent discrete time frames where you’re confirming that a trend is in place”, said Parker.

“So, you’re always looking to capture directional price movement. Obviously, managing risk is paramount, so you manage risk from the trade size, you limit it in the markets and sectors that you trade,” added Parker.

Parker also said that the risk management strategy can be tweaked to adapt to today’s stock market.

“We have a risk management concept that overlays the portfolio that’s based on marginal utility. So, we’re harvesting profits along the way which is very different than what we did learn in the original Turtle trading programs. We’re still doing the same things, just a little bit differently than we used to,” said Parker.

Is turtle trading past its prime?

While Parker claims turtle trading is timeless, other financial experts say that turtle trading went out with Jordache Jeans. Trader Scott Michael Cole believes that turtle trading was innovative in the 1980’s, but wouldn’t be effective now. He believes that the turtles had fewer contracts to hold in a long or short position than traders have now. They only had 12 contracts, while there are many more for today’s traders. Therefore, Cole believes that turtle trading wouldn’t work now.

He contends that inflation was higher and there were more trades to follow in the 1980’s than there are now. Cole believes that turtle trading was effective when Dennis first started. However, with the current low inflation, turtle trading may not be as profitable as it was 35 years ago.

Turtle trading isn’t perfect, not even for the king of the turtles. Dennis himself lost $10 million during the Black Monday crash of 1987. He also had to settle a $2.5 million lawsuit brought by investors. The investors said that Dennis himself wasn’t following the turtle trading rules. Dennis settled the lawsuit with the investors, but denied any wrongdoing.

With fewer trends in the current markets, there is also only about a 40% profit from turtle trading. Traders can expect a 60% loss on average. Turtle trading critics argue that while trend following was profitable in the 1980’s with big stocks like GM (NYSE:GM), there isn’t as much of a payoff now.

Turtle trading could work for patient investors

While there are downsides to turtle trading, there can upsides if investors are patient. Some financial experts note that there are four key facts to remember for investors.

1. Take time with trends. Trend following means catching the trend right in the middle. Don’t rush into trends at the beginning and don’t come into the tail-end of the trend, either.
2. Position sizing should be minimal. In the current volatile stock market, keep each position small. Only risking 1 or 2% of funds on a trade can reduce large losses.
3. Diversification is key. Diversification is pivotal to turtle trading. The turtle traders of the 80’s invested in a wide array of assets, from stocks to foreign currency.
4. Capitalization. Turtle traders don’t need money from Richard Dennis, but they do need a good investing fund to make trades. Because this is low-risk, small-reward investing, emerging turtle traders need a substantial trading nest egg to soften the blow of trading losses, especially during market volatility.

Is there a psychology to turtle trading?

While the Donchian Channel may be an effective tool to measure turtle trading, there were other factors important to the turtle trading system. The turtle system may have worked or not worked for traders because of psychological reasons instead of financial ones. Shannon noted that there was a  “psychological makeup for trading” that outweighed any broker experience.

Dennis noted that mental discipline was just as important to turtle trading as following his rules.

“I always say that you could publish my trading rules in the newspaper and no one would follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80% as good as what we taught our people. What they couldn’t do is give them the confidence to stick to those rules even when things are going bad,” said Dennis.

Slow and steady rule-following wins the trading race

Dennis noted that the psychological aspect of turtle trading was important.

“The majority of the other things that didn’t work were judgments. It seemed that the better part of the whole thing was rules. You can’t wake up in the morning and say, ‘I want to have an intuition about a market.’ You’re going to have way too many judgments,” said Dennis.

Fear and greed are the main driving forces behind trades. Dennis and his turtle traders took emotion about out of an investment. By just following the main rules and diminishing emotional trading, turtle traders can possibly maximize profits, according to Dennis.

“The market does not care how you feel. It will not prop up your ego or console you when you are down. Therefore, trading is not for everyone. If you are unwilling to face the truth about the markets and the truth about your own limitations, fears and failures, you will not succeed,” said Dennis.

Mind over matter in turtle trading

As Al from TradingSim noted in a previous article about trading psychology, “analysis paralysis” can hurt turtle traders. While it’s important to read financial articles from sources like TradingSim, ultimately, a turtle trader has to remove emotions from trading, especially when the market is volatile as it currently is now. It’s important to know when to exit a trade as a winner and when to cut losses.

Turtle traders have to learn to accept the risk that comes with investing. Even if there is limited risk in trend following, any loss can be emotionally devastating if investors put a lot of money in a stock. Even though they are following a trend, trends may change, especially with the current volatility in the stock market. Staying calm, especially during this volatile time, could be pivotal to success in turtle trading.

What questions should turtle investors ask?

Turtle investors may be mentally prepared to trade, but they still have to conduct research. Turtle investors often had to answer these questions every time they made a trade. If investors want to be experienced turtle traders, they should answer these pivotal questions.

1. What is the state of the market?  The state of the market is just the current state of stocks. If Apple(NYSE:AAPL) is trading at $140, that is the current state of the market.

2. What is the volatility of the market?  Risk management was important, so Dennis made sure his turtles monitored the stock market each day. If Apple’s stock fluctuated between $130 and $140, then the turtles said they had 1 N or unit of volatility. So, Apple’s volatility, in this case, would be 10 N.

3. What is the equity being traded? Turtle traders have to know the exact amount of money being traded. If they knew exactly how much they had, they could determine how much they were risking with each trade.

4. What is the system or the trading orientation? In addition to knowing the exact money turtle traders had available, they also had to have an exact plan for buying and selling stocks. That plan prevents traders from buying or selling stocks out of pure emotion. If Apple stock is tanking, a turtle trader won’t panic sell if they stick to turtle trader rules.

5. What is the risk aversion of the trader or client?  Risk management was the name of the game of turtle trading. If a turtle trader has $1,000 to invest, only 1% or 2% should be invested in Apple stock. The minimal risk enabled turtle traders to minimize their losses.

Turtle trading can pay off- but only if risk is managed well

Turtle trading may work now depending on a trader’s own talent- and temperament. In a bull or bear market, there are many factors that may affect turtle traders. They may have more success if futures or commodities instead of more volatile stocks. Successful trading depends on a trader’s own trading education and psychology. Traders may have success practicing simulated trading on TradingSim to determine for themselves if turtle trading is right for them.

Even though Dennis may not have approved of financial information, TradingSim probably would have been a trusted research source for Dennis and his turtles. With simulated trades on TradingSim, budding turtles can have the best risk management of all with no-risk trades.

Whether turtle trading works now or not, it’s a legendary system that will be studied for generations. Dennis noted that training his turtles was easier and more rewarding than he could have imagined.

“Trading was even more teachable than I imagined. In a strange sort of way, it was almost humbling. ”