Turtle Trading Rules

Chapter 16 Risk and Money Management (2)
Consider the example of the turtles.We learned the same thing, and in just two weeks, but some of the turtles didn't even make a dime.Our environment is conducive to making good decisions because we can all hear other turtles' phone calls, but there are still some turtles who don't follow the systems we've learned.

survival first rule
The first goal of trading should be survival.Time is on your side.A system or method with a positive expected value will bring you wealth sooner or later, sometimes huge wealth that you never dreamed of.But there is a prerequisite for all this - you must stay in the game field.For traders, death comes in two forms: a painful slow death, enough to cause traders to give up trading in anguish and depression; and a dramatic and quick death, which we call a crash.

Most novices overestimate their ability to withstand pain. They think they can withstand a 30% or 40% (or even 50%, 70%) decline, but they can't.This is extremely detrimental to their trading, as it often leads them to abandon the trade entirely, or to change strategy hastily after suffering a large loss during a downturn, when it is the last time to change strategy.

Uncertainty about the future is what makes trading difficult, and everyone hates uncertainty.Unfortunately, markets are unpredictable and the best you can hope for is an approach that works in the long run.Therefore, your approach should minimize uncertainty in trading.The market itself is uncertain enough, isn't it absurd to use poor money management to add uncertainty?

Since the Turtle Rule does not predict which markets will trend and which transactions will be successful, Turtles have the same expectations and inputs for any transaction.To the extent possible, this means the same amount of risk in each market.Managing money according to the Turtle Principles increases the likelihood of consistent returns because our methodology adjusts for the relative volatility and risk levels of different markets.

Oversimplified strategies (such as one contract per market) and methods that are not normalized for volatility can lead to overweighting trades in some markets and underweighting others.Thus, even a large profit in one market may not compensate for a small loss in another market if the contract size of the latter is much larger than that of the former.

While many traders intuitively recognize this, there are still many who use an overly simplistic approach to determining how much to trade in a particular market.For example, they might set such a standard: every $2 in account funds corresponds to one S&P 500 index futures contract.They may have been using this simple formula throughout the turbulent last decade.This purely empirical approach may exacerbate the volatility of returns and is completely unnecessary.

position unit size limit rule
As mentioned earlier, Rich and Bill used an innovative method for determining position unit sizes in each market based on the absolute day-to-day fluctuations of the market.The specific number of contracts they calculate for each market will give all markets roughly equal moves up and down.Since the volume traded in each market is adjusted for this volatility measure, N, the daily range of volatility for any given trade will be more or less the same.

Some traders like to measure their level of risk in terms of the difference between the stop exit price and the entry price, but this is only one way to think about risk.In the disaster of October 1987, it didn't matter where our stops were because the market broke everyone's stops overnight.

At the time, if my method had been based solely on the difference between the entry point and the stop loss point, I would have lost four times as much on that day as a typical Turtle, because my stop loss standard was 4/1 theirs.I used a 4/1ATR stop, and most Turtles used 2ATR.Therefore, if I base my position size on the stop draw alone, I will calculate a position size that is 2 times the size of a typical turtle.

Fortunately, Rich uses volatility-based position unit sizing as a risk management tool.Therefore, my position unit size was the same as the other Turtles relative to my account, and I was naturally exposed to the same risk of price volatility as they were.I'm sure Rich and Bill didn't do this by accident; they clearly had fresh memories of the price volatility they'd experienced in the past when considering how to limit the maximum level of risk the Turtles could take.

Limiting our overall level of risk is one of Rich and Bill's smartest moves.This has important implications for our drawdown levels, and in particular our exposure to price volatility.As mentioned earlier, we divide the position into small pieces, which is what we call position units.The number of contracts for each position unit is determined according to the standard: the price change of 1ATR is exactly equal to 1% of our account size.For a $100 million account, 1% is $10000.So, we would figure out the dollar amount in a market that represents a 1ATR move per contract, and then divide that amount by $10000 to get the number of contracts per $100 million of traded capital.We call these numbers the position unit size.If a market is more volatile, or has a larger contract size, its position unit size will be smaller than those in smaller or more stable markets.

Undoubtedly, Rich and Bill had noticed a fact that any half-experienced trader knows: There are a lot of markets that are highly correlated, and when a big trend ends and bad days follow, everything seems to work. start against you.In the turbulent period that follows the unraveling of a major trend, even markets that usually seem uncorrelated begin to influence each other.

Recall the shocking turmoil in October 1987.That day, nearly every market in which we were involved had a sea change against us.It is precisely in response to this situation that Rich and Bill have already imposed some restrictions on our trading volume: first, we can only invest a maximum of 10 position units in each market; In the market, we cannot have more than 4 long or short units; third, our total trading volume in any one direction cannot exceed 6 position units (that is, a maximum of 10 shorts and 10 longs), But for markets where there is no correlation, this limit can be relaxed to 10.Those restrictions may have saved Rich more than $12 million in losses that day.If we hadn't, our losses would have been astronomical.

I often see people claiming that they have historically tested the Turtle systems and found that they performed poorly, or did not make money at all.They will boast, "I've tried every rule except the position size limit." The thing is, the position size limit is an integral part of the Turtle system and an extremely important part because they It is a mechanism to filter out lagging markets.

Interest rate futures are a good example.The Turtles dabbled in four different interest rate futures markets: Eurodollars, U.S. T-bills, 4-day T-bills, and two-year T-bills.On any one move of reasonable magnitude, entry signals would occur in all 90 markets.We generally only take positions in two of these markets at any one time—the first two markets that signaled.

The same is generally true of the foreign exchange futures market.We trade French Francs, British Pounds, Deutsche Marks, Swiss Francs, Canadian Dollars and Japanese Yen.However, we generally only hold positions in two or three of these markets at a time.

In this way, position unit size limits help us avoid many losing trades.In markets that signal last, the trend tends not to last long and we are more likely to end up with a loss.

Risk Metrics
One of the best ways to judge the risk characteristics of a system, or the risks inherent in holding a position, is to look back at the past 30 to 50 years when there have been severe price fluctuations.As long as you recall these catastrophic periods and consider the possible losses on certain types of positions, you can gauge how risky a 50% decline or even outright bankruptcy is.Using computer simulation software, you can easily see what positions you would have held during those catastrophic periods, and what declines those positions would have suffered.

Now imagine what would have happened if something more dire had happened.It may be unpleasant to think about such things, but they can happen after all, and you should be prepared.What would happen to your position if, instead of attacking the World Trade Center, Al Qaeda had detonated a nuclear bomb somewhere else in Manhattan?What if an equally large disaster happened in Tokyo, London or Frankfurt?
Obviously, in the event of such an unprecedented disaster, any aggressive trader is likely to lose his fortune.Don't forget this when you hear the rhetoric of 100%+ returns.

(End of this chapter)