The Legend of the Turtles

One day back in the fall of 1983, famed trader Richard Dennis was shooting the breeze with his trading partner and pal Bill Eckhardt. The conversation followed the lines of the age-old nature versus nurture tack with the central question being, “Are good traders born or can they be made?” Eckhardt was of the opinion that somewhere there's a trading gene, and either you have it or you don't. Dennis expressed his disagreement by flicking a paper airplane at him (okay, I made that up but I like the image) saying that a good trader can be made. At heart, one thing that I've discovered is that all good traders have a touch of the gambler in them, and that was true for our pair. They made a bet. Dennis told Eckhardt that he could teach people to trade and thus launched the saga of the Turtles. But before we get into that, we need to know a little about the man behind the magic, Richard Dennis himself.

Richard Dennis--A Brief Background
Richard Dennis began his career as a runner on the floor of the Chicago Mercantile Exchange (where commodities futures are traded) at the early age of 17. He began trading his own account shortly after using his father as the broker since he was still underage. In just fifteen years, he grew his initial investment of a few hundred or a few thousand dollars (depending on which source you read) into a fortune of a couple of hundred million bucks. How did he do it? He was a sharp guy, and yes, I do think he did have that trading gene in spades. With no formal training or guidance, he instinctively knew when a trade “felt right.” (In college, he majored in philosophy so understanding the ideas behind the ideas must have been an essential pursuit of his.) He took calculated risks, and when he liked a trade, he bet the farm. To avoid making decisions based purely on emotion, he developed mathematical tools to calculate risk and then used them to his advantage, and gradually a complete trading system evolved. That system was the one he taught to his students and become known as the Turtle Trading System. (The Turtle name came from Dennis himself who said that he was going to grow traders just like they grow turtles in Singapore. Personally, I don't think that's a great analogy, but the name stuck nonetheless.)

The Turtles
Getting back to our story, Dennis placed ads in several major financial newspapers and journals looking for people to train. The response was tremendous with over a thousand applicants. He narrowed the field down to 80 prospects and asked them to complete a true/false test comprised of 63 questions. The questions looked inocuous but were actually quite tricky. (I've seen the questionnare and they are, indeed, tricky. Some of them are still being argued in the financial arena.) From this group, he made his final selection of ten plus three that he already knew from outside the group. They were all from diverse social, educational, and professional backgrounds, so he couldn't be accused of selecting just from a specific group, say mathematicians or gamblers (although he did take one gambler into his second training group whom I know personally). He spent two weeks teaching them his system and then let them loose in his office to start trading. Initially, they were given small amounts of money to work with but after they got their sea legs, they were given larger amounts. Many of them did very well. In fact, some of them did so well that they went on to have successful, highly lucrative careers on Wall Street. The ones that didn't fare so well were the ones who didn't follow the rules of the system exactly. Dennis proved himself right--that nurture can indeed triumph over nature, at least as far as trading a rigid system of rules is concerned. I don't know what the bet was, but I hope Dennis cleaned up on it.

The Turtle Trading System: A Complete Trading System
I can't be sure if the concept of the complete trading system was around before Dennis, or if Dennis invented it. Dennis was heavily influenced by the work of Richard Donchian, the subject of yesterday's blog, which is clearly evident if one compares the trading parameters of both systems. Although Donchian did have a set of twenty trading guides composed of eleven general guidelines and nine technical guidelines, he left it to the trader to fill in some of the blanks which were to be deduced from the trader's analysis of market conditions. Dennis took Donchian's guidelines and formed them into a complete set of rigid rules. He did this for one very good reason: to remove all emotion from the process. This is why he won his bet with Eckhardt. As an analogy, my grandmother, when asked how she learned to cook so well, said succinctly, “ If you can read and follow directions, you can cook.” That about sums up the philosophy of the Turtle Trading System.

What is a complete trading system? We touched on the components of it yesterday under the section on trading rules. Today, I'm going into them in a bit more detail. This is because in the next few blogs I'll be using them to give you the recipe for the Turtle Trading System. Here they are again:

1. What are my markets? Your first decision is what markets to trade. Although the Turtles traded futures exclusively, this method can be applied to equities as well. You need to spread your trades around so that you don't miss out on any potential major moves. In other words, you need to diversify among different, uncorrelated sectors. You also don't want to trade any market or equity that has low trading volume or that historically doesn't trend well. You want something that has shown potential for fairly rapid movement since you don't want to wait years to realize a small profit.
2. How much should I buy or sell? This is known as position sizing and is the crux of the Turtle system. It involves spreading risk over different asset classes or sectors through diversification and controlling risk through proper money management. If you don't take away anything else from this discussion, please take note of this component. Money management is something that many training books and seminars either gloss over or don't even bother to teach you, but it's something you need to know to stay in the game. I can't stress this enough.
3. When do I buy or sell? The Turtle System provides exact entry criteria which eliminates the guesswork out of when to buy and at what price.
4. When do I get out of a losing position? The basic tenet of the Turtle Trading System is: Cut your losses and let your profits run. This system tells you the exact price at which you cut your positions and tells you this before you even enter into one.
5. When do I get out of a winning position? As I just mentioned, the Turtles believed that the way to make money is to let your winners run, but they do have rules as to when to exit a winning trade. Any system that does not address this question is not a complete trading system. The lack of any exit criteria would then allow the trader's emotions to come into play and the system ceases to be truly mechanical.
6. How to buy or sell? This topic covers tactical problems such as order execution, what to do during fast markets, and if several markets are breaking out at once, which are the best ones to buy.

Conclusion
I know this might seem like a lot to grasp but once we get into the exact recipe, you'll see it's really pretty simple. Even though you may not agree with the Turtle timing scheme, I think you'll gain a lot from learning their money management techniques. The Turtles themselves have gone on to much success and many an investment firm has their trading philosophy rooted in their rules. But the Turtle System isn't entirely immune to the occasional failure. Even Richard Dennis himself suffered huge losses during the market crash of 1987. That's because in futures trading, losses can be larger than the size of your trading account as opposed to equities where the price of a stock can't go below zero (although your loss is technically unlimited if you're on the short side). Tomorrow, we'll begin cooking up some Mock Turtle Soup so clean up your kitchen. To paraphrase my grandmother (who made the absolute best German potato salad ever, ohmygod!), "If you can read and follow directions, you, too, can cook up a tasty batch of Mock Turtle Soup."