In the 1980s, the American trader Richard Dennis, famously known for trading a wide range of markets entered into an interesting wager with his friend William Eckhardt. Dennis bet Eckhardt that he could teach anyone to trade and ‘grow’, in a manner mirroring how baby turtles are farm-grown in Asia. This experiment came to be known as the turtle trading experiment. Let’s find out what it is.

The Turtle Trading Experiment

Calling his students ‘turtles’, Dennis gave them his own money and taught several rules about the complete trading system. Dennis’ experiment aimed to provide a wholly mechanical approach, along with a set of rules that could help traders eliminate emotions from judgement. The idea was to help traders place their trades only based on rules and nothing else.

Dennis reasoned that even though he could publish all the rules in a newspaper, only a few traders would heed them since most traders tend to avoid following rules rigidly. He mentioned that most people only follow the trading rules as a method of improvising when they deem it necessary and that deviating from the rules can affect the performance of the trade.

What is turtle trading? Understanding the philosophy

The turtle trading strategy is a popular trend-following strategy that traders use to benefit from sustained momentum in the trading market. Used in a host of financial markets, traders employing this strategy look for breakouts, to upside and downside.

Through the experiment, Dennis decided to train 14 ‘turtles’. He taught his students how to create a mechanical strategy of following rules, as opposed to relying on their ‘gut feeling’. He trained a group of novice traders to follow the rules, and those who were successful were given $1 million of Dennis’ own money to manage. Dennis called this experiment the ‘turtle trading’ experiment.

A look at the turtle trading rules

To succeed as traders, Dennis’ ‘turtles’ had to employ the below rules.

  1. The trading markets rule

The first rule revolved around markets traded. As per this rule, the turtles had to trade futures contracts and look for highly liquid markets, which would let them enter into trades without moving the markets, in the absence of large orders. As such, the turtles traded commodities, metals, bonds, energy, currencies and the S&P 500.

  1. The position-sizing rule

In this rule the turtles used a position-sizing algorithm to trade. The algorithm normalised the position’s dollar volatility by adjusting the trade size based on the market’s dollar volatility. This rule is for improving diversification and ensure that every position was the same, irrespective of the market.

  1. The entries rule

The third rule for turtle trading was named the entries rule, in which Dennis’ students used two different entry systems. In the first entry system, a simple 20-day breakout was used and named as the 20-day high or low, while the second used a 55-day breakout. The turtles had to ensure that they took all the available signals and that missing even one signal could mean missing out on a huge winner, which could affect the overall returns.

  1. The stop-loss rule

Dennis taught his turtles how to use stop-loss, asking them to use it all the time to ensure that no loss was ever too significant. They were asked to determine their stop loss before entering a position, thus defining their risk, before placing the trade.

  1. The exits rule

This rule focussed on exits. Dennis explained that exiting a position too early can genuinely limit a possible win, which is a common mistake most trend-following traders make. The turtles were taught to take many trades and shown how only a few of them could be turned into big winners, while the losses on most other trades were minimal.

  1. The tactics rule

The final rule in the turtle trading system revolved around tactics. As per this rule, the turtles learnt a few specifics about how to use limit orders and dealing with fast-moving markets. They also learnt how to wait patiently before placing orders, instead of rushing in and trying to get the best trading price, as most traders do. Dennis also taught them how to buy the strongest markets, while selling the weakest ones, to benefit from momentum.

Final note:

While the results of the turtle trading experiment may have been mixed, there is no doubt that it indeed provides vital information. The fact is that many traders cannot eliminate rules from emotions, but those who can go on to become truly successful traders. To know more about the various trading system rules, visit the Angel Broking website.