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.
William Eckhardt (left) and Richard Dennis (middle). The image has been taken from https://www.trendfollowing.com/turtle/
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.
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 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.