How to gain from the Turtle trading system

One of the most famous trend-following trading systems is the Turtle System developed by US commodity traders, Richard Dennis and William Eckhardt. Even 27 years after it was launched in 1983, traders profitably use variations across a wide range of markets.

The Turtle rules is a very mechanical way to manage risk. The buy-sell signals are simple. Either a 55-day high/low, or a 20-day high/low is a signal, depending on contract volatility. Positions are long for a high, and short for low. Any position is cut-off, if 1-2 per cent of total stake is lost.

Stops and position sizes are based on average true range (ATR). True range for a given session is the largest absolute value of high-low difference, high-previous session close difference and low-previous session close difference. Entry plus/minus the 20-day ATR is assumed as stop loss for a short/long respectively. Assumed loss/unit multiplied by position size gives risk in a given position.

The pluses are easily understood. Turtle equalises risk. The trader never loses disproportionately in a given position though he could gain infinite amounts. It’s easy to monitor. It removes discretionary errors.

The minuses are also obvious. High-lows are unsophisticated signals. The strike rate in terms of profitable signals is barely 50 per cent. Nor is ATR a sophisticated risk-management mechanism. If the prior volatility is low, ATR understates risk. A big trending session in the wrong direction can push well beyond the stop loss before the trader can exit and that scrambles risk-assumptions.

Nonetheless Turtle has worked pretty well in trending markets, including Indian equity. Right now, with a 55-day trigger, the turtle system is neutral on the Nifty. The last buy signal was stopped out on November 11, at 6,250-level, for a large profit. There’s been no sell signal since, due to a pattern of rising 55-Day lows. The ATR has risen steadily through the past three months from 70-odd in early October (@Nifty 6,100) to 107 recently (Nifty 5,892).

A new Turtle buy signal will occur only if and when Nifty 6,338 is exceeded inside the next 30 sessions – roughly till early-February 2011. A sell signal comes only if the market slides below 5,690 before third week of February.

Decoding, we’re seeing a non-trending market with rising volatility. A day-trader could make, or lose, a lot of money scalping 25-50 point swings in a 100 ATR market. A trend player using futures positions should wait for a significant breakout in either direction.

An option trader has two possibilities. He can wait for a breakout. Or he can try and exploit the current range-trading pattern. The former involves buying cheap out of money put or calls and being braced to probably lose a little money, in the hopes of making a lot.

The latter could mean selling out-of-money options and hoping there is no breakout in order to make a little money at a big risk. Or it involves settling premiums close-to-money on minor moves. Both strategies are valid.

The author is a technical and equity analyst