When Stanley Angrist wrote an article for the Wall Street Journal on September 5, 1989, he did not anticipate anywhere close to the response that he received. He relates, “Of the 350 or so articles I published in the Journal, none produced more mail or phone calls than the one on Rich Dennis. [There was no email.] It was wild. People called me up and told me they were quitting their jobs and moving to Chicago. I tried to dissuade them, but I doubt that I succeeded.” His famous piece chronicled the Turtle experiment conducted by Richard Dennis and Bill Eckhardt. The former won the bet by proving that he could create great traders by teaching them to follow specific rules to capture trends in the market. Today, trend following is still the largest component of all major futures indices and spawned the basis for most CTA trading today.
The Original Turtle Trading Rules
While the details may sound rudimentary to today’s knowledge, the simple rubric below worked extremely well in the early 80s. Trading costs were significantly higher, volume was lower, and news traveled slowly. Trading was done in person on the floor of the Chicago Board of Trade instead of electronically as it is currently. This made for more volatile markets, which trended consistently. Richard set up the basic parameters as follows:
- Markets – Each trader was given a specific set of commodity or financial futures to manage. Liquid markets with sufficient price movement were key.
- Position sizing – The number of contracts to be traded, often driven by contract size, strength of the trend, and volatility of the underlying unit. Each “Turtle” was given a specific amount of equity to trade and risked a defined amount of their total per position.
- Entry – When to buy or sell. Determined by a breakout system, which found new highs over 20 days or 55 days.
- Stops – When to exit a losing position
- Adding to winners – If the market moves in the direction of the trade by a specific amount.
- Exits – When to exit a winning position. This could be based on an adjusted stop-loss point that locks in gains or a time exit if the trend stalls.
- Rules were to be followed without exception.
Adapting Trend Following to Modern Markets
To succeed as a trend trader in today’s market, you must do all the basics above, but you must also be different. If everyone followed the same system, newcomers could front-run their trades and take advantage of crowded exits. Uniqueness can be accomplished in several ways. Here are a few:
- Varied time frames—Traditional setups use medium to long-term time frames, meaning weeks to months. Looking at longer-term trends or adding short-term systems changes the profile.
- Profit taking—Modern systems will look at indicators, including overbought or oversold, to adjust positions. Some will add on pullbacks and trim on spikes. Stops can be adjusted quickly or slowly to lock in gains but risk early exits.
- Markets—Often, CTAs look at adding as many markets as possible to increase the potential for good trends. This, however, limits the position size that can go into any one market. Others focus on a discrete subset so each “good trade” is impactful to overall returns. These might include specific sectors, commodities, regions, or contracts based on liquidity.
- Proprietary indicators—Research is constantly at work to evaluate current systems and identify refinements to improve risk-adjusted returns. Moving averages might be a component of most systems, but specific patterns might be discovered that increase the odds of a sustained move.
- Aggression—The number of markets traded often leads to large minimum trade sizes, but many carry excess liquidity. This allows them to use as little as a 5% margin up to the 40% range. Given the same setup, a system could be run at 10% margin and 20% margin. The latter would double the risk and return. Programs should be evaluated on both measures, as a lower-earning program might be better on a risk-adjusted basis.
Pros and Cons of Trend Following Approaches
None of these choices are right or wrong. It is the combination of indicators and rules that determines the ultimate success of the programs. Each idea by itself comes with pros and cons. Shorter-term systems will cost more to trade due to the higher volume. Long-term systems will be slower to adjust to shifts in regimes. Ultimately, each investor needs to understand the driving philosophy that creates success to see if it fits their portfolio because few systems perform in every type of market.
Trend Following in Diversified Portfolios
Trend followers often play a key role in diversified portfolios by providing “crisis alpha.” Their best performance often comes when equities and many other asset classes struggle. This occurs because economic calamity often leads to strong directional moves that continue consistently across markets. Stocks fall, commodities drop, and investors flock into safe havens, including US treasuries and the US dollar. Strong returns can also occur in bull runs, but we often see more variability across trades. Last year, we saw solid equity returns, but many of the best performers earned outsized returns, mostly in cocoa and coffee. Patience is required to achieve the full benefit of this style of trading since traditional investments do well in most periods when trends might be muted, so it may take time for them to shine. Much like insurance on your house, it can be invaluable if you need to use it, and it can help you sleep at night.
How to Get Started in Trend Following
If you are interested in this form of trading for your portfolio, please talk to your IASG representative for guidance. We can help you find a program that fits your risk and reward tolerance and fits within your overall portfolio. Alternatively, you could quit your job and move to Chicago to learn on your own. Perhaps some that ignored Stan’s advice did just that and succeeded wildly. My guess is that they were too late.
Many of the original “Turtles” used the ideas taught as the basis for their own strategies and built successful careers for funds that still exist today. Michael Covel has written several books on the subject. If you are interested, my recommendation would be to start with “The Complete Turtle Trader,” which chronicles the experiment and the story behind it. Alternatively, give us a call. We love talking about trading and the history of our industry.
Check out our trend-following index here.
Photo by Francesco Ungaro on Unsplash