Distinguishing a Strategy from an Indicator: A Lesson from the Turtles

The ” Turtle Traders” are a legendary group of traders taught by commodity trader Richard Dennis.   He and his partner had a debate about whether or not trading could be taught.  They conducted an experiment by placing an ad in the Wall Street Journal and giving a group of traders some accounts and a system.  The turtles ended up making more than $150 million.    Richard Dennis came up with the idea after visiting a turtle farm in Singapore and thought that traders could be “grown” like turtles.

The Turtle Trading System’s entry and exit parameters are quite simple.  They are based on the Donchian channel breakout indicator.  The Donchian channel merely measures the highest high and the lowest low in a series of bars.  For example, if you set the lookback to 10 bars, then the system will give you the highest high/lowest low in the last 10 bars.

The turtle trading system had two different entry systems that could be used. Each one based is based on the Donchian Channel breakout.  The one we’ll consider goes long/short at the highest high/lowest low of the last 20 days.   It exits when when there is a new high/low 10 bars ago.   Here is an example:

If we backtest the indicator, then we will get some information about how it performed historically on BTC prices.  This information can be valuable when thinking about designing a system.   However, my primary purpose in this post is to distinguish between an indicator and a strategy.

Let’s take the Turtle System which is given for fee by one of the former turtles:


Notice that there are at least six things that go into the complete strategy:

1. Markets – What to buy or sell

2. Position Sizing – How much to buy or sell

3. Entries – When to buy or sell

4.  Stops – When to get out of a losing position

5. Exits – When to get out of a winning position

6. Tactics – How to buy or sell

Its important to notice that the entry/exit is only a small part of the entire strategy.  I will illustrate by running two  backtests and compare this with buy/hold.

The first will be a backtest of the Donchian indicator itself as determined by the Turtle trading strategy.  The second will be a backtest that includes the position sizing parameters of the Turtle system.  Each backtest will assume an account of $10,000 with profits reinvested and trade from 1/1/2012 thru 6/1/2014.

Here are the results for trading the Donchian channel indicator itself.  (Note: all profits are reinvested every trade because there is no position sizing strategy.)  The results include a 22 trades- 50% profitable- a profit factor of 1- a drawdown of 98%- and a net profit of $3,482.

Here is a youtube playback of the system.  (You will notice the large drawdown occurs in April 2013).


As is obvious, buy/sell signals generated from the indicator severely underperformed buy/hold.    Buying $10,000 worth of Bitcoin would’ve netted you a nice profit of 1.38 mill.  As you can see below:

Now, let’s consider what happens when we include the position sizing algorithm that the Turtle’s used.  We will follow their rules of only entering 4 units per trade.  Where a unit is defined by (0.01 x AccountSize)/ Dollar per point x the Average True Range).  This position sizing algorithm leads them to enter less money when markets are volatile and more when they are not.   Here are the results using the same time period.

There were 22 trades-50% profitable-a profit factor of 5.27- a drawdown of 98% and a net profit of 3.61 mill.  See below:

I will also add the Youtube playback so you that you can see how the position sizing affected the trading.  Notice the awful trade that occurs in April 2013 doesn’t  destroy all the equity because the trade size is risk adjusted for larger volatility.



Here are some takeaways:

1. An indicator is not a system.  It should not be used as a complete system when trading.  It should not be evaluated as a complete system when backtesting.

2. An indicator that, by itself, underperforms buy/hold can outperform buy/hold when placed in a good strategy.

3.You can learn a lot from a Turtle.  Personally, the 34 pages providedis one of the most concise and helpful pieces on trading that I’ve read.  http://bigpicture.typepad.com/comments/files/turtlerules.pdf

As always, the code is given below:

DonchianIndicatorBacktest TurtlePositionSizing

Trade Well and Prosper






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