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At Yahoo: The Legend of the Turtles


An old trading story rehashed in my latest at Yahoo: The Legend of the Turtles

In 1983, Richard Dennis wanted to settle an argument with William Eckhardt. Dennis, a famous commodities trader, said that trading could be taught as a set of mechanical rules; Eckhardt, a mathematician who had built and traded exactly such mechanical systems, disagreed – he believed there was that little something in a trader that made them successful, something genetic or involving aptitude that made traders great.

In a setting reminiscent of the movie Trading Places (*), they decided to conduct an experiment. They placed an advertisement in the business dailies requesting applications for traders, mentioning that “Prior experience in trading will be considered but is not necessary.” According to Market Wizards (Jack Schwager), more than 1000 people applied, and after a recruitment process involving an exam and interviews, 13 people were selected. Dennis and Eckhardt taught the select traders a “system” – rules that mentioned when to buy, how much to buy and then when to sell. In a trip to Singapore, Dennis had seen a huge vat of squirming turtles being bred in a farm, and decided he would “grow traders just like they grow turtles in Singapore,” which led to the group being named the “Turtles”.

After a two-week training program, each Turtle was given money to trade. The rules were simple. Enter when commodities broke out of a range, and keep adding more positions as they stayed above. Get out when either a well defined stop loss is hit, or when the commodity hits the other end of a narrower range. Size your positions according to the volatility of the commodity – the higher the volatility, the lesser number of contracts you will take on. The Turtles were to risk no more than 2% of their corpus on any single trade.

The result? The turtles ended up making more than $175 million for Dennis in a span of five years, according to former Turtle Russell Sands. The Turtle program was also so incredibly successful that in a year, Echardt and Dennis trained more Turtles, taking the total Turtle count to 23. In 1990, when Schwager wrote The New Market Wizards, he collated the results of a 100 Commodity Trading Advisors (people who manage other people’s accounts), and of his shortlisted top 18, eight turned out to be Turtles.

Dennis and Eckhardt followed a Trend Following system – the idea that if prices show a trend in one direction, you trade in that direction until that trend breaks down. Or, The trend is your friend until it bends. A stock breaking out of a range must in general continue that trend, if it were strong. In many cases you will find that a breakout reverses very fast and hits your stop-loss, taking you out of the trade; but there will be those stocks which break out and give you incredible returns of 200 or 300%, negating the smaller losses when you were stopped out.

So if there really is a formula to make money, why isn’t everyone following it?

  • Today, the rules are public. Having public rules is thought to make trading them ineffective, because if people know what you’re going to do, they can use it to your disadvantage. But it’s not that simple, because while rules can be written down, it’s incredibly difficult to follow them diligently. Richard Dennis famously said he could publish trading rules in a newspaper and no one would follow them – the key being consistency and discipline. We rely on our “intuition”, that in this particular stock I won’t respect that stop-loss, because Tata Steel is going to turn around just now. That tends to be the downfall; and sometimes “intuition” changes to “into-wishing”, as another famous trader Ed Seykota has said.
  • Second, markets change. From a strong uptrend in 2007, we had a steep downtrend in 2008, and then a range bound market till the great rally of 2009. Indeed, even in 2010, our index did nothing for the first eight months – nearly all of the gains this year were in the month of September. A trend-following index trading system would have been severely damaging to the pocket for most of the year – can you imagine continuously losing money on fake breakouts for nearly one year, before you realize one large gain? Chances are that you would have stopped the discipline and decided that the system has stopped working. But the rules of Turtle trend trading require trading different, uncorrelated markets -if you traded Gold or Silver in the last year, the return would have been quite spectacular. That means one needs to constantly research where the trends lie and be ready to move money into different markets; or to develop a set of rules that work in trending markets and another that work in range-bound markets, and create a way to transition between the two. For the Turtles, the range-bound market of 1991, just a year after Schwager interviewed a few of them, was very tough – trend-following systems tend to underperform in such times.
  • Third, the problem is in what a fellow trader calls the stomach lining. On paper it is easy to watch Rs. 1 lakh grow to Rs. 50 lakhs in a few years, by testing the rules using historical data. But what you might not see is that there was a “drawdown” of 30% in the system; that means you saw your portfolio fall 30% before it started to rise again. The stomach lining is simply the amount of such loss you can take in real life – for some people, even a 10% loss will trigger palpitations, and some others will stay calm even at 50% losses. (Especially if it’s someone else’s money.) You have to find out what works for you – there is no size that fits all. The turtles had to have this in them – and regardless of what the result turned out to be, I think the Turtles experiment found people who had strong stomach linings.
  • Lastly, while most people focus on entries and exits, an important part of the play is money management. Trading has largely been seen as “I got in at 100, I sold at 500”. But no one asks you – how much did you buy at 100? If I wasn’t too confident I might have bought just 50 shares – the resulting gain of 20,000 doesn’t really put me in a higher income tax bracket, or sound nearly as impressive. A great trend following system could be destroyed by putting too little or too much – remember, a 100% loss means you have no more money to buy into the next trade – which may be the one that gives you your 10x return. Another famous trader saying, one that I’ve mentioned earlier: If you don’t bet, you can’t win. If you lose all your chips, you can’t bet.

The Turtles set their money management according to the amount they could lose per trade, and then on volatility. For example: On a portfolio of Rs. 10 lakhs (1 million), if your maximum loss was 2% per trade, you are prepared to lose only Rs. 20,000 on each trade. Let’s say that Tata Steel shows potential at Rs. 650 and you would like to set a 10% stop-loss. How many Tata Steel shares would you buy? Buying a 100 shares is too little – the Rs. 65,000 investment will get stopped out at 10%, or Rs. 6,500 – which is far lower than your threshold. A 500 share buy-in takes on a 32,500 rupee loss potential; far greater than you desire. The position you want is 300 shares – and if you widen the stop loss, you’ll reduce the number of shares. This is true regardless of whether you have a lot of money sitting as cash; if you take a risk you can’t afford, the risk will take you.

Disciplined trading has been taken to the other extre
me using technology. If emotions betray us, then why not codify the rules into programs and have computers trade entirely on their own? The automated trading market has been increasing since the early 90s. The foreign exchange market is considered to be largely computers talking to each other, without human intervention; even in stocks, “algorithmic trading” has now become immensely popular. Even the Turtles systems are now offered as off-the-shelf “black box” products which you buy and connect to your brokerage service (not in India yet). The skewed incentives now may be that system developers tend to make more money selling their systems rather than trading them; what drives the market is more about the presentation of performance than actual profits.

A systematic trading system needn’t be everything an investor looks for, but the discipline in the approach is useful for any investor – to follow the rules, even if your gut says otherwise. And yet, there will be times to follow your instincts, largely because of the emotional dissatisfaction of ignoring them. Lessons in this field are expensive – you can actually count what you pay for doing the wrong thing – but like you can’t learn to swim by reading a book, you can’t make money trading without losing some.

* And, if you’re into it, Mark Twain’s The £1,000,000 Bank-Note.

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