Trend Following: A complete guide into TurtleTrading and their legacy
Michael Covel has dedicated three books on the legendary turtle traders group and their so-called “trend following” trading strategy. This article is my personal view of his work, the lessons I personally took from them, as well as my opinion on them.
This article should not be viewed as a replacement of the book but rather as an introduction or as a side guide. Everybody learns and takes away different things from a book from another.
The Story Behind the Legend
Although trend following is an old concept, it took form after the Chicago trader Richard Dennis started the turtle traders group. Other historical traders that had been categorized as trend followers include David Ricardo, Jesse Livermore, Richard Wyckoff, Arthur Cutten, Charles Dow, Henry Clews, William Dunnigan, Richard Donchian, Nicolas Darvas, Amos Hostetter, and Richard Russell.
It all started when Richard Dennis and William Eckhardt got into a debate on whether or not trading could be taught. To settle this debate, Richard Dennis posted an advertisement in the Wall Street Journal, Barron’s, and the International Herald Tribune, in 1983, in order to find his students. This had, as a result, the formation of the first turtle traders group that was compiled of 21 men and 2 women.
One turtle trader visited Singapore at one point in time and saw a turtle farm. When returned, the name “turtle traders” was suggested to the group as a metaphor. Richard Dennis was raising a trader out of each one of the traders, as the farmer was raising turtles on the farm.
After a 2-week intensive theoretical training, each turtle got an account funded by his own money, for them to trade individually. When the experiment ended, they had produced a $175'000'000 profit.
Here it is worth mentioning that from the whole 23 initial turtle trader group, only 1 person trades to this day and has his own trading company. His name is Jerry Parker.
In 1984, was the second way of turtle traders, and in 1985 a third.
My Personal Intakes from Michael W. Covel’s Books
The following are lessons that I found useful inside Michael Covel’s books. I do not necessarily agree with all of them, but I surely find them interesting.
- Think of money as a way to keep score and lose any emotional connection to them.
- Do not afraid to follow your trading system when your money management is set.
- Good trading and intelligence are not correlated. Emotional intelligence, on the other side, is way more important.
- Your long-term progress is your only performance metric.
- Do not revenge trade, meaning do not try to make up for lost positions. Move on.
- Follow what the market gives and do not oppose personal opinion on the market.
- Self-discipline is the most important characteristic of a trader’s personality.
- Money management, or as it is also known risk management or bet and position sizing, needs to be the first topic a trader will master.
- No trader wins every time. When he or she wins though wins big, and when loses, he or she loses small.
- Do not risk more than 2% of your account in any trade.
- The exit is more important than the entry.
- Cut your 2% risked amount, mentioned-above, by 20% each time you achieve a 10% drawdown on your account.
- When we enter into multiple positions with correlated assets, we introduce our portfolio to more risk. We could either lower our 2% risked amount to every position or use uncorrelated assets.
- Use either the lower level of a 10-day DOnchain channel as an exit or a double-daily-volatility amount.
- A trader can win or lose by luck in the short term. In the long term, luck plays no role.
- Follow your strategy, even if you lose five trades in a row. This will also remove any emotion from your trade.
- A trader needs a trend to make money, and thus the name “trade following.” Do not trade a sideways market.
- Buy when the price moves above the high of the two previous weeks, and sell when the price moves below the low of the two previous weeks.
- Plan your next day in advance.
- A trader needs to know the volatility of the assets he or she follows. (use the Average True Rande (ATR) indicator for a 15-day average.)
- Add to your winners when the price makes a move equal to the amount of the daily volatility level. This will be used as a compound to your account.
- Trading is a “zero-sum” game. The amount that one trader wins is the amount another trader has lost.
- Traders do not forecast or predict the price. If you ask a trend follower for a forecast, they should answer “I do not know.” They simply follow the direction of the market according to their strategy.
- Do not listen to the news, stock tips, reports, etc. Nobody can predict the future and thus the markets. Traders need to simply follow the price.
- Every piece of information concerning an asset is already calculated inside its price. The markets then are efficient.
- Black swan events can and will happen from time to time.
- “Markets in motion tend to stay in motion.”
- Nobody can pick the bottom or the top of a move so do not worry about it.
- Fundamentals are useless to a trader. True price movers are always unknown.
- There is no reward without risk.
- There is no such thing as the price is too high or too low in an asset.
The Trend Following Strategy
The preparation takes place a day before every trading day. Every trend follower needs to able to answer four key questions at any point in time for the assets that they follow. They need to be aware of the price level at which every asset they follow, the volatility levels, their equity that can be at risk, and the direction of the market.
Stop Losses: Take whichever hits first.
(System 1) Stop Loss 1: When we measure volatility (with the ATR indicator) each day, we set the value equal to “N.” If, for example, the daily volatility of a stock is $10, then this is our “N.” We exit when in a day we get a 2N value. In our example, a $20 move.
(System 2) Stop Loss 2: We exit a bullish position when the price breaks the 10-day lower lever of a Donchian channel, and we exit a bearish position when the price hits the 10-day upper level of a Donchian channel.
Adding to your winners:
When we know our “N” value, we simply add to our position whenever our position moves 1N to our favor. If, for example, our N is $10 and our chosen stock moves +$10, we buy one more stock.
Use of trading indicator “Donchain channels” and have the upper line set to 20 days and the lower line set to 10 days. Learn more about this indicator in my article “Indicators for Traders: Donchian Channel.”
A trader needs to experiment with different day lengths and find what suits him or her the best. A good starting point is the ones mentioned above.
Example 1: Berkshire Hathaway Inc — Bullish Move
Bullish direction: Our bullish entry signal should be when a candle touches and breaks the upper line, and our stop loss should be just below the red line lower line of the indicator. We move the stop loss as the lower red line moves upwards.
In the example below, you can see from left to right, a possible entry when the first green candle broke the green upper line of the indicator. We followed the red line as a stop loss until the price touch the red line and closed our position. The yellow arrows and line shows our gain.
Example 2: USD/EUR— Bearish Move
Bearish direction: On a downwards market, we need to set our trade the opposite of how we would set it on a bullish market. We set our entry point when the price touches/breaks the lower red line, and we follow the green line with our stop loss.
Example 3: Basic Fit — Sideways Move
We just stay away from a sideways market. If there is no trend, we do not have anything to follow, and thus no “trend following.” Trend is always your friend.
Step 1. Calculate the 2% of your account. This is the amount you must risk per trade. If you want to enter into multiple trades, either choose noncorrelated assets or lower the 2% risk level to a lower percentage.
Step 2. Chose the asset you want to trade and check if it is already trending. If on a bullish trend, then you look to enter into a bullish position. If bearish, you look to enter into a bearish position. Do not open a position on an asset that makes a sideways move.
Step 3. Add the Average True Range (15) indicator to your chart and check the daily ATR range. That’s the daily volatility (1N) amount of this instrument. If the price makes a 1N in your favor, you add to your position. If the price makes a 2N move against you, you close your position.
Step 3. Bullish: You add a Donchian channel indicator with a 20-day upper level and a 10-day lower level. You enter a position when the price hits the upper level, and you exit the position when the price hits the lower level.
Step 3. Bearish: You add a Donchian channel indicator with a 10-day upper level and a 20-day lower level. You enter a position when the price hits the lower level, and you exit the position when the price hits the upper level.
Reading all the books and listening to the interviews was a time-consuming process. The “complete trader” was focused on the story of turtle traders, the “trend commandments” was interesting, but the “trend following” was my least favorite book. Trend following was a huge read and much of the time was focused on the history behind and the validation of the trend following technique as a legit profitable trading technique, rather than the technique itself. I wish that it was more straight foreword.
- The Complete TurtleTrader by Michael W. Covel
- Trend Commandments by Michael W. Covel
- Trend Following by Michael W. Covel
- Interview with Jerry Parker one of the original Turtle traders: https://chatwithtraders.com/ep-067-jerry-parker/
- “Trading for Beginners” Course from Investopedia: https://academy.investopedia.com/products/trading-for-beginners
- The Little Book of Trading (Trend Following) by Michael W. Covel
You must be aware of the risks and be willing to accept them in order to invest in these markets. Don’t trade with money you can’t afford to lose. The information contained in this article is for educational purposes only and is not to be a recommendation for any specific investment. Trading any market carries a high level of risk, and may not be suitable for all investors.