The Way of the Turtle

1. Trade with an edge: Exploit market inefficiencies and cognitive biases

"Turtles view the past holistically and don't put any particular emphasis on recent events."

Cognitive biases create opportunities. Traders can gain an edge by recognizing and exploiting common psychological tendencies in market participants. These include recency bias (overweighting recent events), loss aversion (fearing losses more than equivalent gains), and the disposition effect (holding losing trades too long and selling winners too early).

Trend following capitalizes on inefficiencies. The Turtle trading system primarily exploited momentum and the tendency for trends to persist longer than most people expect. By using simple breakout rules and adding to winning positions, Turtles were able to capture large trends across diverse markets.

• Key biases to exploit:
  • Recency bias
  • Loss aversion
  • Anchoring
  • Herd behavior
• Turtle edge: Riding trends longer than others expect

2. Manage risk: Control position sizes and diversify across markets

"If you don't keep an eye on risk, it will set its eye on you."

Position sizing is crucial. The Turtles used a sophisticated volatility-based position sizing system that normalized risk across different markets. This allowed them to take similar-sized bets in terms of risk, regardless of the underlying asset's price or volatility.

Diversification enhances returns. By trading a wide range of uncorrelated markets, the Turtles were able to smooth out returns and reduce the impact of drawdowns in any single market. They also had strict rules limiting exposure to related markets and overall directional risk.

• Turtle position sizing:
  • Based on Average True Range (ATR)
  • Normalized volatility across markets
  • Limited exposure in correlated markets
• Benefits of diversification:
  • Smoother equity curve
  • Reduced impact of single market drawdowns
  • More opportunities for profit

3. Be consistent: Follow your system religiously to achieve long-term success

"Good trading is not about being right, it is about trading right."

Consistency is key to long-term success. The Turtles who performed best were those who followed the rules most consistently, even during drawdowns or periods of poor performance. Deviating from the system, even with seemingly good reasons, typically led to worse outcomes.

Mechanical systems remove emotion. By following a set of clearly defined rules, traders can avoid many of the psychological pitfalls that lead to poor decision-making. This allows for more consistent execution and the ability to stick with winning trades longer.

• Benefits of consistency:
  • Captures infrequent but large winning trades
  • Removes emotional decision-making
  • Allows for proper evaluation of system performance
• Dangers of inconsistency:
  • Missing key trades that drive annual returns
  • Inability to distinguish system flaws from poor execution
  • Emotional reactions leading to larger losses

4. Keep it simple: Complex systems are prone to overfitting and failure

"The core of our approach was simple: catch every trend."

Simplicity leads to robustness. The Turtle trading rules were surprisingly simple, based primarily on breakouts and trend following. This simplicity made the system more robust and less likely to fail when market conditions changed.

Avoid overfitting. Complex systems with many rules and parameters are often "curve-fit" to past data and perform poorly out-of-sample. By focusing on a few key principles that work across many markets and time frames, the Turtles created a more adaptable approach.

• Advantages of simple systems:
  • More robust to changing market conditions
  • Easier to understand and follow consistently
  • Less prone to overfitting
• Dangers of complexity:
  • Increased risk of curve-fitting
  • Difficulty in consistent execution
  • False sense of precision

5. Think in probabilities: Focus on long-term expectancy, not individual trades

"Turtles do not care about being right. They care about making money."

Embrace uncertainty. Successful traders understand that they cannot predict the future with certainty. Instead, they focus on strategies with positive expectancy over many trades, accepting that any individual trade may be a loser.

Avoid outcome bias. The Turtles were taught to evaluate their trading based on how well they followed the rules, not on the outcome of any single trade. This mindset allows traders to stick with profitable systems even during inevitable losing streaks.

• Key probability concepts:
  • Positive expectancy
  • Law of large numbers
  • Random distribution of wins and losses
• Psychological benefits:
  • Reduced emotional attachment to individual trades
  • Ability to withstand drawdowns
  • Focus on long-term results

6. Master your psychology: Overcome cognitive biases and emotional reactions

"Human emotion is both the source of opportunity in trading and the greatest challenge."

Recognize your biases. Successful traders understand their own psychological tendencies and work to counteract them. This includes overcoming the natural inclination to hold onto losing trades and cut winning trades too early.

Develop emotional discipline. The ability to follow a system consistently, even when it goes against your instincts or emotions, is crucial for long-term success. This often requires practice and conscious effort to overcome natural psychological reactions.

• Common trading psychology challenges:
  • Fear of missing out (FOMO)
  • Inability to admit mistakes
  • Overconfidence after winning streaks
• Strategies for improvement:
  • Meditation and mindfulness practices
  • Keeping a detailed trading journal
  • Regular review and self-assessment

7. Embrace failure: Learn from losses and use them to improve your system

"If you persist, you will move closer and closer to your goal, or you may find that another goal becomes even more important."

Losses are inevitable. Even the most successful trading systems will have frequent losses. The Turtles understood that losing trades were a normal part of the process and not a reflection of personal failure.

Use losses as learning opportunities. By analyzing losing trades and drawdowns, traders can refine their systems and improve their understanding of market behavior. This iterative process of learning from failure is key to long-term growth and success.

• Healthy attitudes toward losses:
  • View them as a cost of doing business
  • Use them to test and refine your system
  • Recognize that even large drawdowns are normal
• Ways to learn from losses:
  • Detailed post-trade analysis
  • Regular system review and optimization
  • Studying market conditions that lead to losses

8. Adapt to changing markets: Recognize when conditions shift and adjust accordingly

"Markets are comprised of individuals, all with hopes, fears and foibles."

Markets evolve over time. The Turtles recognized that market conditions and behavior can change, sometimes dramatically. Successful traders must be able to recognize these shifts and adapt their strategies accordingly.

Maintain flexibility. While consistency is important, blindly following a system that no longer works can be disastrous. The best traders strike a balance between adhering to their rules and recognizing when fundamental changes require adjustments.

• Signs of changing market conditions:
  • Increased correlations between markets
  • Changes in volatility regimes
  • Breakdown of historical relationships
• Adaptation strategies:
  • Regular review of system performance
  • Incorporating new markets or instruments
  • Adjusting position sizing or risk parameters

9. Diversify strategies: Combine uncorrelated systems for more robust performance

"A robust trading program is built on the premise that you cannot predict the specific market conditions you will encounter in your actual trading."

No single strategy works all the time. By combining multiple uncorrelated trading approaches, traders can smooth out returns and reduce the impact of drawdowns in any single system.

Exploit different market inefficiencies. Different strategies may perform better in various market conditions. By diversifying across approaches (e.g., trend following, mean reversion, volatility trading), traders can capture profits in a wider range of environments.

• Benefits of strategy diversification:
  • Smoother equity curve
  • Reduced maximum drawdowns
  • More consistent overall returns
• Examples of complementary strategies:
  • Long-term trend following + short-term mean reversion
  • Systematic + discretionary approaches
  • Fundamental + technical analysis

10. Focus on execution: Entries matter less than proper position sizing and risk management

"The Turtle Way works and continues to work because it is based on the market movements that result from the systematic and repeated irrationality that is embedded in every person."

Entry signals are overrated. Many traders obsess over finding the perfect entry signal, but the Turtles demonstrated that even simple breakout entries can be highly profitable with proper risk management and position sizing.

Risk management drives returns. The Turtles' success was largely due to their sophisticated approach to position sizing and risk control. This allowed them to maximize profits on winning trades while limiting losses on losers.

• Key components of good execution:
  • Consistent application of rules
  • Proper position sizing based on volatility
  • Use of stops to limit losses
• Areas often overemphasized by novices:
  • Complex entry signals
  • Attempts to predict short-term price movement
  • Frequent trading or overtrading

11. Continuously learn and improve: Study markets, refine your approach, and stay humble

"I think it is easier to make a lot of money if you don't really want it badly."

Markets are always changing. Successful traders never stop learning and adapting. They study market history, analyze their own performance, and remain open to new ideas and approaches.

Maintain intellectual curiosity. The best traders are often voracious readers and learners, constantly seeking to expand their understanding of markets, psychology, and risk management. This continuous improvement mindset is crucial for long-term success.

• Areas for ongoing study:
  • Market history and behavior
  • Trading psychology and decision-making
  • Risk management and portfolio theory
• Ways to improve:
  • Regular performance review and analysis
  • Studying other successful traders and systems
  • Experimenting with new ideas in small sizes

Last updated: October 6, 2024