What is a turtle trading strategy

The Turtle Trading strategy is a trend-following system that uses 20-day price highs or lows to signal trades, aiming to capture major market moves.

Core Principles of Turtle Trading

The Turtle Trading strategy is a trend following trading system designed to catch supply-and-demand based trends as soon as possible with very prescriptive, systematic rules, and without recourse or dependencies. This is meant to be mechanical so that emotions are weeded out from trading decisions.

Identification of Trends

The first practice of Turtle Trading is breaking out as a way to identify trends. Dennis and Eckhardt gave their traders (known as the Turtles) a simple system to follow: Buy or sell a commodity or stock when it made a new twenty day high or low. In this strategy, a trader only considers price actions and does not delve into the basics of how the market actually works.

For instance, if gold hit a 20-day high, the Turtles would add to their short position. Theoretically this should benefit from the large gains that come from major market moves but the equally excess draw downs would outweigh these profits.

Risk Management

One thing that is clear implementing the Turtle strategy is the emphasis on proper risk management. Risk is kept to 1-2% of equity per trade with each trade under control. Implemented in this disciplined manner, no one trade has the ability to significantly alter the trader’s balance. The volatility of the markets determines what position size is used, with more volatile market such as cryptocurrencies typically seeing smaller position sizes to keep with the level of risk that has been defined.

Use of Stops

One of the mainstay aspects of Turtle trading is the implementation of stop-loss orders in order to exit losing positions promptly. When the turtles went into a new position, they established stop-loss orders. The stop was two ATR (Average True Range) away from the entry price, as it adjusts the amount of bars to enter according to vice value. This strategy prevents incurring a huge loss and the trader may able to save his capital even in case of worse conditions available in the market.

Following the Rules

The last principle follows the rules of the game and only employs them to become a winning player. The Turtles gave you a set of rules that you had to follow in order to replicate what made their teachers successful. Not following these rules was akin to causing your own underperformance.

Key Components of the Strategy

The Turtle Trading strategy is characterized by a few fundamental components that orchestrate its unique approach to financial markets. These components focus on clear entry and exit points, risk management, and strategic use of stop-loss orders to protect investments.

Entry Rules

The entry strategy for Turtle Trading hinges on the concept of breakouts. Traders are instructed to initiate a buy order when the price of an asset exceeds the high of the previous 20 days or sell when it falls below the low of the same period. This systematization aims to capitalize on significant market moves that follow these breakouts.

To quantify, if Apple’s stock hits a 20-day high of $150 per share, a Turtle trader would place a buy order, anticipating further upward movement.

Exit Rules

Exiting a position at the right time is crucial to securing profits and limiting losses. The Turtles used a detailed exit strategy based on stop-loss orders and a “20-day low” rule for selling. If a stock drops to or below this threshold, it signals a potential reversal of the trend, prompting an exit.

For example, if after buying at $150, Apple’s stock drops to $140, aligning with the lowest price in the past 20 days, the position would be closed to prevent further loss.

Stop-Loss Orders

Stop-loss orders are essential in managing risk and preventing substantial losses. Turtles set these orders not just to exit losing trades but also to ensure that no single trade could detrimentally affect their overall portfolio. Typically, these stops are placed at a distance of two Average True Range (ATR) measurements from the entry point, effectively tailoring the risk level to current market volatility.

This means if the ATR is $5, the stop-loss would be set at $10 below the entry point for a long position.

Position Sizing

Position sizing in the Turtle system is dynamically adjusted based on the volatility of the market using the ATR. The higher the volatility, the smaller the position, balancing the risk across varying market conditions. This calculation helps maintain uniform risk management across all trades.

Position sizing is crucial; for instance, in a highly volatile market, reducing the size of the trade helps keep potential losses within manageable limits.

The Turtle Trading Rules

The success of the Turtle Trading strategy is anchored on a set of meticulously defined rules that guide the traders’ actions. These rules, established by Richard Dennis and William Eckhardt, cover every aspect of trading, from when to enter and exit trades to how to manage risk effectively. Each rule is designed to remove emotion from trading decisions, relying on market data to dictate actions.

Breakout Signals for Entry

The Turtles were trained to enter the markets on breakout signals. A breakout is confirmed if the price moves above the high of the last 20 days for a long position, or below the low of the last 20 days for a short position. This rule is intended to ensure traders are positioned on the right side of significant market movements.

For instance, if the price of crude oil breaks above its 20-day high of $70 per barrel, a Turtle trader would take a long position, expecting the upward trend to continue.

Exit at 10-day Lows for Long Positions

The exit strategy is equally rigid. For long positions, an exit signal is given when the price hits a 10-day low. This quick exit strategy helps to cut losses early and preserve gains from other successful trades.

When a stock purchased at $100 per share drops to a 10-day low of $95, it triggers a sell order, minimizing potential losses.

Using Stop-Loss Orders

Stop-loss orders are critical in the Turtle strategy to manage risk. Each trade comes with a predetermined stop-loss level set using the ATR indicator, which measures market volatility. The typical setting involves placing a stop-loss two ATRs away from the entry price, ensuring some buffer against market noise but not so wide that the loss becomes significant.

If entering a trade on gold with an ATR of $15, the stop-loss would be placed $30 away from the entry point.

Position Sizing Based on Market Risk

Position sizing varies with the perceived risk in a trade, calculated using the volatility (ATR) of the asset. Higher volatility leads to smaller positions to manage the greater risk, while lower volatility allows for larger positions. This dynamic adjustment helps maintain consistent risk exposure across various trading conditions.

In a highly volatile market, a trader might risk only 0.5% of their capital on a single trade, as opposed to up to 2% in more stable conditions.

Performance and Effectiveness

The Turtle Trading strategy has been a subject of extensive study and debate within the trading community. Its performance and effectiveness are often highlighted through historical returns, which showcase the potential of this trend-following strategy.

Historical Success Rates

During its inception in the mid-1980s, the Turtle Trading system was phenomenally successful, reportedly earning millions of dollars in profits. The original group of Turtle traders, selected through a unique training program, demonstrated that disciplined adherence to the strategy could yield substantial returns.

One notable example includes a Turtle trader who started with $1 million and earned over $30 million within four years. This success rate highlighted the potential of systematic rule-based trading to outperform more subjective or discretionary trading approaches.

Comparative Performance Against Benchmarks

When evaluating the effectiveness of the Turtle Trading strategy, it is essential to compare its performance against traditional market benchmarks like the S&P 500. Analyses indicate that during periods of strong market trends, Turtle Trading strategies significantly outperformed these benchmarks, benefiting from large and sustained price movements.

For instance, during the commodity bull market in the late 2000s, Turtle strategies excelled by capturing extended trends in oil and gold prices.

Adjustments and Modern Relevance

The changing dynamics of global financial markets have necessitated adjustments to the original Turtle rules. These adjustments reflect changes in market volatility, trading volume, and the introduction of new financial instruments.

Modern adaptations might include recalibrating entry and exit points or adjusting the ATR calculation period to better suit current market conditions. Such tweaks are crucial to maintaining the strategy’s relevance and effectiveness in today’s fast-paced markets.

Criticisms and Limitations

Despite its successes, the Turtle Trading strategy is not without its critics. Some argue that its reliance on historical price trends may not always predict future movements accurately, particularly in markets that are becoming increasingly influenced by algorithmic trading and artificial intelligence.

Critics point out that during market phases characterized by sideways movements or lack of clear trends, the Turtle strategy may underperform or generate significant losses.

Challenges and Critiques

Despite its historical success, the Turtle Trading strategy has prompted several exchanges within trading community. These difficulties relate to its capability to change market problems, the psychological stress imposed upon traders, and efficiency in lateral market problems.

Adaptability to Modern Markets

One of the primary criticisms of the Turtle Trading strategy is its reliance on conditions that favor long-lasting market trends. In today’s highly volatile and often erratic markets, these prolonged trends are less common, making the strategy less effective than it was during the 1980s.

For instance, the strategy may present false signals in high-frequency trading scenarios when price jumps are sharp but short-lived which in turn means more stop-loss orders getting triggered and hence possibly resulting in gains.

Psychological Strain on Traders

The approach of the Turtle Trading strategy is subject to strict rules which may also have a burdensome psychological impact on traders. Since the strategy is mechanically based, traders must trade in a robotic fashion, if they want to be successful.

This is especially hard to manage during drawdowns where the strategy may go through a series of losing trades consequently testing the trader’s resolve and dedication to their model rules.

Performance During Range-Bound Markets

A final criticism over the Turtle Trading strategy is how it would preform during a market that is either range bound or moving sideways. The strategy requires volatility and as well defined trends, so this lack of market direction can be its downfall.

Quantitatively, the strategy may underperform when key indices such as the S&P 500 are exhibiting low volatility and following a lazy trend of slow price movement over prolonged series, thereby generating periods that see breakeven or losing outcomes.

Relies On Parameter Settings

In addition, the parameters used with the Turtle Trading strategy plays a big role in defining how effective it will be (e.g., what length to use in the breakout signals and where to set stop-loss orders). You can also be a very bad trader if your parameter setting wrong.

For example, adjusting a standard 20-day breakout to a 30-day breakout will delay entry points, meaning that the trader can miss initial opportunities and potential profitable movements or enter a trend too late.

Scroll to Top