Introduction

The following information provides background on the major concepts of turtle trading.  Explained is trend following and why it will continue to work in the future, as well as to point out the dangers and shortcomings of some other types of trading methodologies.  The following information is based on comments provided by one of the original 14 'Turtles' selected out of a group of more than 2,000 applicants.  These 'Turtles' were then taught by Richard Dennis to apply his trading techniques.  Many professinal money managers to use these techniques

Trend Following Explained

A trend can be defined as a random drift with a 'bias' in a particular direction.  This direction can be up, down, or sideways.

1.  Trend - Price trend implies more price trend.  In the absence of anything else, follow this advice.  This is key to making profits with the turtle trading methodology.

2.  Loss Management - Cut and run with losses.  This applies both to positions and to equities.  You want to be able to come back and play another day.

3.  Profit Management - As quick you are to abandon losses, be equally steady with profits.  Do not give in to the temptation to cut profits short.

Why Does Trend Following Work?

1.  It is a statistically valid concept to have a "bias" in the otherwise random drift of a serice of numbers.

2.  The markets only allow a few people to make money, and the majority of traders, regardless of what they might think, or say, do not know how to do it correctly (trend following).

3.   The markets exhibit maximum perversity.  This means that the trends will only come about after most of the people have lost most of their money and have already given up in disgust.

Then, when they do come, and nobody believes it any more, eventually these people have to start chasing the market, and that's what makes the trend continue.

React to Market Moves, Don't Predict the Market

"When a new trader examines the trading problem, his first reactin os that in order to be successful, he must learn to predict the markets.  Minimum research will teach him that you use fundamental analysis to make long term predictions and technical analysis to make shorter term predictions."

This is a dangerous misconception, as nothing could be further from the truth!

The fact is that we do not know what the market is going to do, and we should never expect that we will know.  The correct way to consider the problem is how we are going to react to whatever it is the market chooses to do.  We cannot control the market.

One of the basic premises that we follow is that "the price is always right."  The market tells us what it is going to do.  If the price (of anything) is going up, then the market is in an uptrend.  If the price (of anything) is going down, then the market is in a downtrend.  Since we are trend followers, we simply want to jump on board.

There is a major difference between the idea that "the price is going up, therefore, I want to buy it," which is what trend followers do (reaction), and the idea that "I think the price is going to go up, so I should buy it," which is what the crystal ball gazers do (prediction).  Remember, nobody can consistently predict the future!

There is no reason to look at anything that is only a derivative of price when you have the oppertuninty to observe price directly.  All the indicators in the world can be pointing to a market that "should" be going up, but if the price isn't going up, then the price is not going up.  It is that simple.

Closely related to the concept of price is that the market is always right.  How many times have you bought something because it looked like it should be going up according to whatever indicator you happen to be using.  Then when the market proceded to go down, you said something to yourself to the effect of "that can't be right, the market should be going up."  Guess what?  The market is always right.  If you focus only on price and remember this about market behavior, you will save yourself alot of money in the long run.

Cut Your Losses and Let Your Profits Run

Everyone knows about cutting your lossed short, so we won't spend much time on this subject.  I you can do 99 other things right, but you don't do this one right then you are destined to lose.

One of the hardest rules to follow is that of being agressive when you are ahead.  On a good winning position the natural inclination is to sell and take profits, not to add more to the trade.  This comes from a false belief that you can make money by taking small profits and not be greedy.  This is wrong.  If we believe thatprice is the strongest indicator of correctness of market action, then having a good profit on a trade is an indication of doing something right.  And if you are doing something ringh, you want to do more of it, knot counteract it.  Do not be afraid to add to a winning trade.  This is sometings the hardest thing to do.  

You must resist cutting profits.  A losing trade typically will last only a few days or so.  A winning trade will typically last one to three months.  You must have patience.

Some Problems With Other Methods

In all of the Turtles research, nobody has ever found a counter trend method that works.  The major problem with the counter trend or "support and resistance" tyupe of methods is that they force you into a situation of cutting your profits short and potentially letting your losses run.  The exact opposite of what you should be doing.

If you "lean" agianst a support level by buying something at the end of a horizontal consolidation, then by deninition you must take your profit if and when the market climbs to the upper end of that channel.  Any such methodology which offers you a predetermined profit level or target violates the basic rule of letting your profits run.

The appeal of such methods is that they can be accurate more than half the time.  Where these methods fall short is that the probability of success is only half of the equation when it comes to trading.  Even more important than the probability of success or failure is the "expected return" from your trade execution.

It is the size of the wins and losses that is important, because it is obvious that you can have a system that will win on 70% of its trades and still lose money in the long run.  Similarly, you can have a system that only wins 30% of its trades but still makes money in the long run.  Bad things, like nasty gaps right though yor stop loss points, tend to happen to your with much greater frequency when you are positioned against the trend of the market!  It is this unfortunate situation that puts you in violation of the basic rule by letting your losses run.

Trend Following Will Continue to Work

The size of the playing field has increased dramatically, and it continues to grow all of the time.  While the amount of money under control of the trend following methods has increased approximately 10 fold in the past decade, the total amount of money in the market has increased 25 times as much.

Much of the new money is under control of bank traders coming into the private sector, pensoin funds, and dicretionaly traders who have no regard for trend following analysis.  It is these "other" trader and their methodologies that will tage the opposite side of our trend following trades, providing continued liquidity to the marketplace.