Turtle Trading Rules

Chapter 6 Demystifying Turtle Thinking (2)
Outcome preference refers to a person's tendency to judge a decision as good or bad based on its final outcome rather than its quality.When it comes to risk and uncertainty, there are many questions for which there are no right answers.For this reason, a person sometimes makes a decision that he thinks is reasonable and appears to be the right one, but due to factors that were not and could not be foreseen, the decision does not lead to the desired result.

Outcome bias can lead people to place too much emphasis on what actually happened and overlook the quality of the decision itself.In the trading world, even the right approach can lose money, and it is even possible to lose money in a row.These losses can cause traders to doubt themselves, doubt their decision-making process, and judge negatively about the method they have been using because the results of this method are negative.Combined with near-term bias, this problem becomes especially acute.

Recency bias is when a person places more weight on recent data and experience.A deal from yesterday is more important than a deal from last week or last year.The experience of losing money in the past two months may be as important as the experience of making money in the past 6 months, or even more important.Thus, a recent string of unsuccessful trades can lead traders to doubt their methods and decision-making procedures.

The anchoring effect refers to people relying too much on easily available information when making a decision involving uncertainty.They may stare at a recent price level and make decisions based on the relationship between the current price and this reference price.That's why my friends are so reluctant to sell stocks: they just stare at recent highs and compare the current price to those highs.Current prices always seem too low in comparison.

People tend to follow the herd to believe something just because other people believe it. This is known as the bandwagon effect or the herding effect.This bandwagon effect is partly responsible for keeping prices skyrocketing even as the bubble is about to burst.

People deluded by the law of small numbers believe that a small sample is an approximately accurate reflection of the overall situation.The term law of small numbers comes from the law of large numbers in statistics.The law of large numbers means that a large sample drawn from a population can approximately and accurately reflect the population. This law is the theoretical basis of all public opinion surveys.A random sample of 500 people drawn from a group of people can very accurately represent the opinions of 2 million or more people.

In contrast, a small sample is not very representative of the population.For example, if a trading system works 6 out of 4 times, most people would say it is a good system, but statistically there is not enough information to support that conclusion.Likewise, if a mutual fund manager outperformed the index for 3 consecutive years, he would be considered a hero.Unfortunately, performance over a few years is not indicative of long-term performance.Belief in the law of small numbers can lead to premature confidence building, or premature loss of confidence.Combined with the effects of near-term bias and outcome bias, traders tend to jettison an efficient system just before it starts to work.

Cognitive biases have an immeasurable impact on the trader, because if a trader is immune to these biases, then every bias represents an opportunity to make money.As we go into the details of the Turtle's approach in later chapters, you'll see that avoiding these cognitive biases can give you a huge advantage.

Turtle Trading Strategy
Now that we have looked at the psychological characteristics of a trader, let's look at the different ways of trading.Every type of trading strategy or style has its true followers.In fact, some traders admire their particular style so much that any other style is out of their reach.I don't have this bias.Anything that works is a good method.It is foolish to cling stubbornly to one approach to the exclusion of all others.This section will introduce some of the most popular trading styles at present, the first one is trend following (trend following).

trend following
A trader using this method tries to capitalize on a big trend over several months.Trend followers enter the market when the market is at an all-time high or low and get out if the market reverses and the reversal persists for a few weeks.

In order to accurately determine when a trend begins and when it ends, traders spend a lot of time studying many judgment methods.But all approaches lead to the same goal, and all effective methods share some very similar characteristics.Trend-following can generate solid returns and is consistently invincible, but most people find it difficult to stick with this strategy for several reasons.

First, megatrends rarely occur, which means that trend-following strategies have a much higher probability of failure than success.For a typical trend following system, 65% to 70% of the trades may lose money.

Second, trend following systems fail not only when there is no trend, but also when the trend reverses.A common saying among the Turtles and other trend followers is: "The trend is your friend until the trend is over." Trend ends and reversals are a brutal blow to your account and your spirit.Traders call this period of losses a decline.A downturn usually follows a trend, but in the case of a sudden market turn, the downturn can last for several months.During this time, trend following strategies will keep you losing money.

Fading is generally measured in terms of its duration (days or months) and degree (usually in proportion).In general, the declines of trend-following systems roughly approximate the level of their returns.So, if a trend-following system has an expected return of 30% per year, then during a down period, your account could drop 30% from its high.

Third, the trend-following method needs to use a relatively large amount of funds to ensure reasonable risk control, because there is a large gap between the entry price of this method and the stop-loss exit price in an unfavorable situation.

If you have too little money, using a trend-following strategy can greatly increase your chances of going bust.We'll talk about this in more detail in Chapter 8.

counter trend trading

When the market is not trending, counter-trend traders make money through strategies that are the exact opposite of trend-following.Instead of buying when the market makes new highs, this type of trader sells short when prices are near new highs.Their rationale is that breakouts to new highs mostly do not trigger market trends.In Chapter 6, we will talk about the source of profit in counter-trend trading: the support and resistance mechanism of the market.

swing trading
Swing trading is essentially the same as trend-following trading, except that it targets short-term market movements.For example, a successful swing trade may last only three or four days, not a few months.Swing traders usually look for patterns in market fluctuations to determine whether prices are likely to move significantly in a certain direction in the short term.

Swing traders like to use short-term price charts, that is, charts that show price changes every 5 minutes, 15 minutes, or every hour.A three- or four-day trend is considered a major trend on these charts, as is a three- or six-month trend on a daily chart.

day trading
Day trading is not so much a style as it is a representation of extreme short-term trading.A true day trader always tries to get out of the market before the end of each day's trading.That way, even if negative news that broke out overnight triggered a sharp change after the opening bell, their positions would have little impact.Day traders typically use one of three trading strategies: position trading, scalping, or arbitrage.

Day traders often also use strategies like trend following or counter-trend trading, but for a much shorter period of time.A deal might only last a few hours, not days or months.

Snatching is a special kind of trading that used to belong only to those floor traders on the exchange.Hatters try to earn the difference between the bid price and the ask price, known as the spread.If gold buys at $550 an ounce and sells at $551 an ounce, a hatter will try to buy at $550 an ounce and sell at $551 an ounce.Thus, hatters create liquidity for the market as they bid and ask incessantly, hoping for a balance between buy and sell orders.

Arbitrage strategies exploit price differences within the same market or between very similar markets.Different markets are often located in different trading venues.For example, an arbitrageur might buy gold at $550 an ounce on the Comex floor and simultaneously sell gold at $555 an ounce on the Chicago Board of Trade's Globex electronic trading platform. An e-mini gold contract to capture fleeting price imbalances.

market status

Each of the above trading strategies has a market environment that is more suitable for it, that is, when the market is operating in a certain way or in a certain state, the strategy is more effective.

The speculative market is divided into the following four states:
Stable and Calm: The price moves up and down within a relatively small range and rarely goes outside of it.

Stable fluctuations: There are large diurnal or weekly variations, but no significant monthly variations.

Quiet Trend: Prices exhibit a slow movement or trend over several months, but there are no sharp pullbacks or countermovements throughout.

Volatile Trend: Large price changes, occasionally accompanied by sharp short-term reversals.

Trend followers love calm trends.In such a market, they can make money without having to endure drastic adverse changes.It is very easy for a trader to hold on to a trade for a long period of time because the market will not let the profit shrink during this time.Volatile markets are trickier for trend followers.It's hard to stay calm when profits are constantly disappearing into thin air for days or weeks on end.

Counter-trend traders like stable and volatile markets.Although this type of market has relatively large fluctuations up and down, it always stays within a fairly narrow price range.Swing traders love volatile markets, trend or not.There are more opportunities in volatile markets because swing traders make money from the short-term price fluctuations that are a fundamental characteristic of volatile markets.

Although it is sometimes not difficult to determine which state a market is in, both the strength of the trend and the degree of volatility will vary.This means that the market often presents two different state characteristics at the same time, and the value of a certain attribute will change from low to high, or from high to low.For example, a market may be calm at the beginning with a trend, but as the trend progresses, the volatility gradually increases, and the price movement changes from a calm trend to a fluctuating trend.

The Turtles never predicted the market's movements, but looked for signs that the market was in a certain state.This is an important concept.Good traders don't try to predict what the market will do next; instead, they watch for indicators to determine what state the market is in right now.

(End of this chapter)