It is hard to get too far into managed futures without eventually hearing a reference or two to ‘Turtle Trading’ or ‘Turtle Traders’.  But what exactly is a turtle trader?

It all started with trading legend Richard Dennis. He and his partner- William Eckhardt, another titan in the field- had experienced massive success and pondered the question of whether great traders are born as such, or whether they can be taught. [sort of like the Dukes in Trading Places]

Dennis contended that anyone could be successful in the futures market, but Eckhardt believed that Dennis was just really good at what he did. To prove Eckhardt wrong, Dennis posted an ad in the Wall Street Journal, soliciting students to teach his methods to.

14 traders were selected in the process, and Dennis got to work teaching them a systematic method of trading futures markets (the turtle trading method). There are many books and websites detailing what those methods were, with debates over who was and was not an actual turtle, but the overall approach was essentially a trend following strategy with a volatility based position sizing method.

The basics of trend following are to bracket the market on either side with something like Bollinger Bands or moving averages which encompass 90% of a market’s price action. The next step is to enter into a long trade when the market prices go through the upper band (signaling a new up trend) and go short (bet on falling prices) when the market’s prices go through the lower band (signaling a new down trend).  Position size is usually based on the distance between the entry and a moving average of prices, with larger volatility markets resulting in fewer contracts. Usually trend followers then stay in the trade until prices fall back to something like a 100 day moving average.

This has historically been a nice way to trade the markets, and is the basic premise behind nearly every success story in futures trading lore – from the Turtle Traders to John Henry (owner of the Boston Red Sox). But the knock on trend following, and why many of the huge firms of today don’t necessarily like that categorization anymore – is that it is a reactive strategy which is often too slow in both getting into trends and getting out of them with any profits left over. This reactive logic has been known to cause steep drawdowns as the system waits and waits to get out of a formerly profitable trade.

Michael Covel, in his 2007 book The Complete Turtle Trader: The Legend, the Lessons, the Results, explained some of the basic principles Dennis conveyed:

• Look at prices, not commentary, for guidance.
• Use some flexibility in setting your buy and sell parameters.
• Plan your exit as you enter.
• Use the “average true range” to calculate volatility, and vary your position size based on the information.
• Don’t risk more than 2% of your account on one trade- ever.
• If you want returns, get used to drawdowns.

Dennis’ Turtle Traders went on to experience great success, with the first two classes of turtles gaining $175 million in 5 years [past performance is not necessarily indicative of future results]. Other turtles were not so successful, though Turtle proponents argue they failed because they failed to follow the turtle system “precisely.” We can’t say for sure whether or not that’s true. Regardless, in our experience, we’ve found that there are a number of reasons a program can fail, ranging from strategy to marketing inadequacies to business management deficiencies, so we understand some of the turtles failing out along the way.

Today, many managed futures programs display turtle-esque qualities, with the most common theme being a systematic way of getting into and out of trades (and systematic way of determining how many contracts to trade). Before the turtles much heralded success, it was widely believed the way to trade futures markets was to analyze crop reports, weather patterns, and supply/demand factors.  After the turtles, a new era of systematic traders came into being – and these many years later – the bulk of the managed futures industry is run of such systematic programs.

So next time you hear us referring to a turtle trader, banish from your mind any thoughts of an ancient tortoise trying to keep up in a hectic world. Instead, think of the infamous bet between Dennis and Eckhardt, the concept of systematically setting position size, and a piece of trading history that will not soon be forgotten.