Turtle Trading Rules

Chapter 27 Defense System (2)
Take the cocoa market mentioned in Chapter 4 as an example.Remember, this market was trending well after a string of losses.This situation is very common.Another example that deserves special mention is my experience with the Turtles.In early 1985, Rich asked us to stop trading coffee.I think it's because the coffee market is too small for us, and we've been losing money on our cocoa trade.It was this decision that caused us to miss one of the best opportunities of the entire Turtle era (see Figure 13-1).

Since I didn't take this trade, I can't tell you exactly how much I lost. I used the March 1986 coffee contract as a test.At the entry point, the N value is 3 cents, which means my position size should be 1.29 contracts since I have been trading in 103 with a $1985 million account.Since each trade is 500 position units, I will be buying 4 contracts on this trade.The profit per contract is about $412, so the total profit for 34000 contracts will be about $412 million - that is, a return of 1400% of the account capital of $500 million on this one trade.In the Turtle era, no transaction can compare with this opportunity that passed us by.

But does that mean we have to cover all markets indiscriminately?Is there no reason for us to exclude a certain market?of course not.The main reason for excluding a market is liquidity issues.A market that is not actively traded and does not have a lot of volume is much trickier than a market that is highly liquid.The better you do it, the more this factor limits you.That's why Rich banned us from trading coffee.Our volume itself was huge, and with Rich's trades, we were buying and selling thousands of coffee contracts as we entered and exited the market.This is of course close to the limit of market capacity.So Rich's decision was a very reasonable one, although I'd rather he hadn't made it.

You might think that if you have a small account, you can choose this illiquid market.This may be true, depending on what system you are using, but it may also be false.The problem with illiquid markets is not that you have trouble getting in and out in normal times, but that you have too many contracts to buy or sell in some particular situation, and no one on the other side.Low liquidity in the market means there are too few buyers and sellers, so your buy order for 200 or 500 contracts could wait a day and not get filled because there are no sellers.This situation is not easy to occur in a market with relatively high liquidity.

Illiquid markets are also more vulnerable to price volatility.Look at brown rice, lumber, propane, or any other market that trades less than a few thousand contracts a day, and compare that to the highly liquid markets, and you'll find far more unexpected moves in illiquid markets.

Three types of markets

There is another reason for excluding specific markets.While I don't think markets that are relatively lagging in simulation testing should be ruled out, I do believe there are some fundamental differences between certain types of markets that make it necessary to completely exclude certain types when using a particular trading system market.

Some traders believe that every market is different and therefore the way to trade in each market is also different.I don't think the reality is that simple.In my opinion, markets are actually divided into three broad categories that differ significantly from each other, but within a category, the differences between markets are largely due to random events.These three categories of markets are:

1. Market fundamentals.Such as foreign exchange market and interest rate product market.In such a market, the main driver of price movement is not trading behavior, but higher level macroeconomic events and influences.This has become less and less obvious as the times have changed.But in my opinion, the monetary policy of the Federal Reserve, similar institutions in other countries, and a country's government still have more influence on the foreign exchange and interest rate product markets than speculators.These markets have the highest liquidity, the clearest trends, and are the easiest to grasp for trend followers.

2. The market for speculators.For example, the stock market and futures markets such as coffee, gold, silver, and crude oil.In these markets, speculators have more influence than governments or those big hedgers.The price is determined by the market attitude.These markets are more difficult for trend followers to grasp.

3. Comprehensive derivative market.In such markets, speculation is the main driver of the market, but the degree of speculation is tempered because the trading instruments are derivatives of other markets, which are themselves complexes of corresponding stocks. The e-mini S&P 500 futures contract is a good example.It also fluctuates up and down, but the range of volatility is limited by the S&P 500 index.Likewise, the S&P 500 is only indirectly influenced by speculators.Since an index combines the purely speculative fluctuations of multiple stocks, there is a dynamic equalization and neutralization effect.For trend followers, such markets are among the most difficult to navigate.

My take is: no matter what type of market it is, all markets in the same type are the same, and you just need to make a decision based on the type and liquidity of the market.I never touched the third market in Turtle days, but many other Turtles were different from me.I don't think our system is good enough for derivative synthetic markets.That's not to say you can't pick these markets, it's just that the medium-term breakout trend-following system we have is not suitable for these markets.That's why I never traded the S&P in Project Turtle.

Markets in the same category are all much the same.Occasional differences exist, of course, and sometimes last for years or even decades, but in the long run, you will find that these differences are only derived from the trader memory effect (trader memory) and the underlying cause of the general trend relative rarity and randomness.

trader memory effect

The bullion market is a good example of the memory effect for traders.When I first entered the industry, because people still remember the incredible trend in 1978 (gold rose to $900 an ounce and silver went to $50 an ounce), it was almost impossible to make money in the gold market. possible.Every time the market showed even the slightest sign of rising, everyone started scrambling to buy gold, which made the price too volatile.The market is always up and down, and up and down.In short, it is difficult for a trend follower to make a difference in such a market.Now, 20 years have passed, and most people have forgotten the situation in 1978, so the market in the spring of 2006 is far easier to grasp than before.If you just compare the charts, you will feel that the gold market itself has changed.

I don't think anyone knows when a market like gold will move again and a market like cocoa will trend again.Just because a market hasn't had a big trend in the past 20 years doesn't mean it's not a good market.In my opinion, as long as a market is large enough and distinct from the rest of your portfolio, you should go for it.

Market diversification is often limited by the amount of capital, because entering multiple markets at the same time with an acceptable level of risk requires certain capital requirements.The amount of funds is one of the reasons why successful hedge funds are more comfortable than individual traders, and the performance of big traders is more stable than small traders.If you can only choose 10 markets because of limited funds, your performance will be more unpredictable than traders who enter 50-60 markets at the same time.If you want to trade futures with a long-term trend-following system at a reasonable level of diversification, you need at least $10.And even with this level of diversification, the level of risk is too high for most traders.

use multiple different systems

In addition to decentralization across different markets, you can also increase robustness by decentralizing the system.If several trading systems are used at the same time, especially systems that differ greatly from each other, the robustness of the trading will be greatly improved.

Consider these two systems: the better one has a RAR of 38.2% and an R-cube of 1.19; the worse one has a RAR of 14.5% and an R-cube of only 0.41.If you tested both systems, which one would you choose?Is it the better one?This sounds like a logical choice.

However, such a choice ignores the decentralized advantages of two unrelated systems.This advantage is even greater if the two systems are negatively correlated (that is, if one system makes money, the other tends to lose money).It is for this reason that certain systems are more powerful when combined, just look at the data below.

If both systems are used together, RAR and R-cube will reach 61.2% and 5.20 respectively.Needless to say, this is much better than either system alone.

In fact, these two systems are the two parts of the Bollinger Breakout System.The better system only trades long channel breakouts and the worse system only trades short channel breakouts.It's easy to see why the combination of the two systems works, but it's really surprising how large the effect is.

Combining systems suited to different market conditions has the same effect.For example, if one system performs well in a trending market and another system performs better in a non-trending market, we can combine the two.When one suffers a decline, the other may prosper, and vice versa.This strategy doesn't necessarily work as well as you might expect, but it does greatly increase the robustness of your trade.

Just like market diversification, system diversification is limited by the large capital and effort involved in using multiple systems at the same time, which is where successful hedge funds have an advantage over individual traders.You might need $20 for a decent spread of one long-term trend-following system, or as much as $100 million for four or five different systems at the same time.That alone may force many to hand over their money to those professional futures fund or hedge fund managers, rather than bite the bullet and do it themselves.

It is impossible for you to foresee what kind of market state you will encounter in actual trading, which is the premise of a sound trading strategy.With this in mind, traders should build robust systems, that is, flexible and simple systems that are not too dependent on specific market conditions.Also, well-established robust strategies that use many different systems in many different markets are much more stable than a few systems that are highly restricted to a few markets.

(End of this chapter)