- Wealth PMS (50L+)
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?
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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