a breakout system
Post on 04-Dec-2015
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DESCRIPTIONA Complete Trading System Used by Professionals to Make Millions
A Complete Trading System Used by Professionals to Make Millions
SpecialFX posted an article : 5 Dec
If there's one thing that most traders are always looking for, is a set of rules or a system that
allows them to trade the markets profitably. In this article I will describe a complete trading
system used, in the past, by a very famous trader and the people he taught, and then later
on by several hedge funds managed by his disciples.
It can be used "as is", without any modifications, or you can use it as a basis to develop your
own system, further enhancing the power of the original rules.
► The Turtle bet
In the early-1980s, one of the greatest and richest traders of the 20th century, Richard
Dennis, and his friend Bill Eckhardt, were having an ongoing discussion on the viability of
teaching people how to trade. Richard was convinced that it was possible to teach ordinary
people to become good traders, while Bill believed that great traders possessed a natural
skill, some sort of sixth sense that could not be taught.
In order to settle this discussion they made a bet: they would recruit a few inexperienced
people for their trading company, C & D Commodities, teach them the rules of the system
they already used, give them capital to trade, and then see if they had become good traders
These people would become known as "The Turtles", because Richard once famously said:
"we are going to grow traders like they grow turtles in Singapore".
► The philosophy behind the system
Richard and Bill did not believe that the future direction of the markets could be predicted
consistently in the long run, so it was futile to even attempt it. Their whole approach to
trading was based on following the market's momentum after a breakout. The idea behind it
is that once the market breaches a resistance/support (previous high/low), it is likely to
continue in the same direction.
Losing trades are quickly closed once the stop-loss is hit, while winning trades are kept open
until the trend reverses, no take profit orders are used.
They were also convinced that a mechanical trading system with rigid rules was the best way
to trade, because this way many of the emotions that demonize a discretionary are
minimized and even erased. A good mechanical trading system makes it possible to be
consistent all the time, and consistency is a key skill to have in order to be successful.
► Ingredients of the system
Even though the original system used daily bars, you can use any time-frame you wish.
However, the shorter the time-frame the lower the profit factor of any system will be, due
to trading costs remaining constant and profit potential getting lower. A good technical
system should be time-frame neutral, so if you see a system which requires a very specific
time-frame to work, be cautious.
Like the time-frame, a good system should work on all markets, as long as their are liquid,
and the costs are low. The Turtles traded currencies, bonds, and commodities with this
system. I advise trading as many currency pairs at the same time as possible (scaling back
the amounts accordingly), because diversification, when done correctly, is the best way to
lower risk while keeping the profit potential intact.
- ATR 20
- Donchian Channel 10, 20 and 55. This indicator forms a channels and simply shows the
highest high and the lowest low of the last n periods.
► Preparing your charts
Open up your platform and add a ATR 20 indicator. Now add a Donchian Channel 55, with
high values in blue, low values in red, and line width 3, like this:
Then add a Donchian Channel 20, blue and red again, line width 2. And finally a Donchian
Channel 10, still blue and red, line width 1, line style dashed (---). This is how it should all
look like in the end:
This is just for cosmetic purposes, you can use other colors and line widths, but these ones
► Finally the rules
This system is formed by two sub-systems. System 1 uses a shorter time-frame based on 20-
bar breakouts, while System 2 uses a longer time-frame based on 55-bar breakouts.
Open a long or short position if the price exceeds the high or the low price respectively of
the past 20 periods (Donchian Channel 20).
If the previous 20-bar breakout resulted in a profitable trade this new breakout would be
ignored. The previous breakout for this rule is considered the previous breakout shown in
the chart, irrespective of its direction (long or short), or whether or not that trade was
actually opened, or skipped because of this rule.
If a 20-bar breakout is ignored, you are at the risk of missing a big trend, if the price
continues to move in the direction of the breakout, so this is where System 2 is useful. If the
price exceeds the 55-bar high/low you open a long/short position respectively, in case you
didn't open a trade at the 20-bar breakout. All 55-bar breakouts are taken, whether or not
the previous one was a winner.
The system uses manual trailing stops, so a System 1 trade would be closed if the price
moved against the position and exceeded the 10-bar low/high.
System 2 trades would be closed if the price went against the position and exceeded the 20-
These exits can be very far away from the entry price, so the initial stop-loss is placed at 2 x
ATR 20 for both systems. Example, if the ATR is 50 pips, then the initial stop-loss would be
placed 100 pips from the entry price, and then manually updated once the 10 or 20-bar
low/high is lower/higher than the initial stop.
Position sizing and money management
I'm not going to fully describe all rules in this subject because they are unnecessarily
complicated for an average trader, and we have to remember that they traded futures
contracts with fixed sizes, so the calculation for position sizing is a bit different for spot
You can use the money management calculator I made, which is perfect for Forex, while still
adhering to the principles of this system. It will indicate the correct amounts to trade as well
as where to place the initial stop loss, given the ATR and how much of your capital you want
The Turtles risked 2% of their accounts on each trade, and could have 12 positions at the
same time. If you trade 20 uncorrelated pairs I would advise risking around 1-1.25% on each
trade, 10 pairs 1.5-1.75%, 5 pairs 2-2.25%, and 1 pair you can risk 5% at the most (live
► What to expect with this system
Being a trend-following system, it is obviously very profitable when there are clearly defined
trends in the market, and will experience losses when the market is trading sideways. The
win ratio of a system like this, which focuses on quickly closing losing trades while keeping
winning trades open until the trend reverses, is around 35 to 40%, but winning trades will be
larger than losing ones, so the risk-reward ratio is at least 1:2.5 or 3. In the long run, you will
make money with such statistics.
Drawdowns depend on the leverage used and level of diversification, but as a rule of thumb
you can expect to have a maximum drawdown similar to the CAGR. So if the leverage you
use makes it possible to achieve a CAGR of 25%, you can expect to eventually have a
maximum drawdown of about 25% as well. Risking 1.25% per trade and using 20 pairs you'd
probably achieve this CAGR over the long run.
This is not a perfect system, especially taking into consideration that the markets are
choppier and have more false breakouts these days than in the 1980s. A good way to
improve it would be add a filter that keeps us out of the market when there are no trends.
For example, adding a 200SMA and only opening long trades when the price is above the
200SMA, and short if it is below. Remember, there are no perfect systems, but this one - and
others similar to it - have consistently produced profits for the last 3 decades.