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.

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► 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

or not.

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".

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► 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.

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► Ingredients of the system

Time-frame

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.

Recommended pairs

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.

Indicators

- 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.

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► 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

work well.

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► 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.

Entries

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.

Exits

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-

bar low/high.

Initial stop-loss

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

Forex.

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

to risk.

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

accounts).

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► 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.