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Trading Rules

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33 views

Trading Rules

Uploaded by

gogamer961
Copyright
© © All Rights Reserved
Available Formats
Download as TXT, PDF, TXT or read online on Scribd
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1 RISK JUNKIES

High risk, high reward: It takes balls of steel to play this game.
—Told to a friend before starting the Turtle program

2 TAMING THE TURTLE MIND


Human emotion is both the source of opportunity in trading
and the greatest challenge. Master it and you will succeed.
Ignore it at your peril.

3 THE FIRST $2 MILLION IS THE TOUGHEST


Trade with an edge, manage risk, be consistent, and keep it simple.
The entire Turtle training, and indeed the basis for all successful
trading, can be summed up in these four core principles.

4 THINK LIKE A TURTLE


Good trading is not about being right, it is about trading right.
If you want to be successful, you need to think of the long run
and ignore the outcomes of individual trades.

5 TRADING WITH AN EDGE


Trading with an edge is what separates the professionals from the
amateurs. Ignore this and you will be eaten by those who don’t.

6 FALLING OFF THE EDGE


Edges are found in the places that are the battlegrounds
between buyers and sellers. Your task as a trader is to find
those places and wait to see who wins and who loses.

7 BY WHAT MEASURE?
Mature understanding of and respect for risk is the
hallmark of the best traders. They know that if you don’t keep
an eye on risk, it will set its eye on you.

How many times have you felt these emotions while trading?

• Hope: I sure hope this goes up right after I buy it.


• Fear: I can’t take another loss; I’ll sit this one out.
• Greed: I’m making so much money, I’m going to double my
position.
• Despair: This trading system doesn’t work; I keep losing
money.

Here are some of the cognitive biases that affect trading:

• Loss aversion: The tendency for people to have a strong


preference for avoiding losses over acquiring gains
• Sunk costs effect: The tendency to treat money that already
has been committed or spent as more valuable than money
that may be spent in the future
• Disposition effect: The tendency for people to lock in gains
and ride losses
• Outcome bias: The tendency to judge a decision by its
outcome rather than by the quality of the decision at the
time it was made
• Recency bias: The tendency to weigh recent data or
experience more than earlier data or experience
• Anchoring: The tendency to rely too heavily, or anchor, on
readily available information
• Bandwagon effect: The tendency to believe things because
many other people believe them
• Belief in the law of small numbers: The tendency to draw
unjustified conclusions from too little information

speculative markets exist in one of four states:

• Stable and quiet: Prices tend to stay within a relatively


small range with little movement up or down outside that
range.
• Stable and volatile: There are large daily or weekly changes,
but without major changes over a period of months.
• Trending and quiet: There is slow movement or drift in prices
when measured over a period of months but without severe
retracement or price movement in the opposite direction.
• Trending and volatile: There are large changes in price
accompanied by occasional significant shorter-term reversals
of direction.

Good traders don’t try to predict what the market will do; instead they look at the
indications of what the market is doing.

Turtles
were taught how to think in terms of the long run when trading and
we were given a system with an edge
Risk of Ruin

However, risk of ruin is


a trader’s primary consideration in deciding how many contracts of
a particular market or shares of a particular stock to trade at any
specific time.

What size bet would you make if you had only $1,000 in your
pocket: $1,000? $500? $100? The problem is that even though the
game is in your favor, you still have a chance of losing. If you bet too
big and lose too many times in a row, you could lose all your money
and forfeit the ability to keep playing through pure chance. If you
bet $500 and lose twice in a row, you’ll be out of money.

The Science of Controlled Risk

Money management refers to managing the size of market risk


to ensure one’s ability to keep going through the inevitable bad
periods that every trader experiences. Money management is the
science of keeping your risk of ruin at acceptable levels while
maximizing your profit potential.

The Turtle Mind


• Think in terms of the long run when trading.
• Avoid outcome bias.
• Believe in the effects of trading with positive expectation.

The Turtles were encouraged to look at the long-term results of


a specific approach and ignore the losses we expected to incur
while trading with that approach. In fact, we were taught that peri
odds of losses usually precede periods of good trading. This training
was critical to both the Turtles’ potential success and their ability
to keep trading according to a specific set of rules through extended
periods of losing trades.
The lessons of the Turtle class can be summed up in these four
points:

1. Trade with an Edge: Find a trading strategy that will


produce positive returns over the long run because it has a
positive expectation.
2. Manage Risk: Control risk so that you can continue to trade
or you may not be around to see the benefits of a positive
expectation system.
3. Be Consistent: Execute your plan consistently to achieve
the positive expectation of your system.
4. Keep It Simple: The core of our approach was simple: catch
every trend. Two or three trades might account for all your
profits, so don’t miss a trend or you might kill your whole
year. This is simple and easy to understand, not easy to do.

Turtles do not care about being right. They care about making
money. Turtles do not pretend to be able to predict the future. They
never look at markets and say: “Gold is going up.” They look at the
future as unknowable in specifics but foreseeable in character. In
other words, it is impossible to know whether a market is going to
go up or down or whether a trend will stop now or in two months.
You do know that there will be trends and that the character of
price movement will not change because human emotion and cognition
will not change.

If you have 10 losing trades in a row and you are sticking to your plan,
you are trading well; you are just having a bit of bad luck.

To overcome the third affliction, you need to think about the


future in terms of possibilities and probabilities rather than in terms
of prediction.

People tend to think in terms of likely or unlikely but


never in terms of probabilities. That is why insurance companies
insure against uncertain risks. An event such as a hurricane destroying
your house is one such risk. There is a certain probability that
there will be a hurricane that affects your house if you live near the
tropical ocean. There is a slightly lower probability that the hurricane
will be strong enough to damage your home. There is an even
lower probability that it will be powerful enough to destroy your
home completely.
If you knew that your house would be destroyed by a hurricane with
100 percent certainty, you would not buy insurance; you would move.

Trading is much the same as insuring against uncertain risks.


Trading is filled with uncertainties. You do not know whether a
trade is going to make money. The best you can do is be confident
that the rewards will outweigh the risks over the long run

Dos and Don’ts for Thinking Like a Turtle


1. Trade in the present: Do not dwell on the past or try to predict
the future. The former is counterproductive, and the latter is
impossible.
2. Think in terms of probabilities, not prediction: Instead of trying
to be right by predicting the market, focus on methods in which
the probabilities are in your favor for a successful outcome over
the long run.
3. Take responsibility for your own trades: Don’t blame your
mistakes and failures on others, the markets, your broker,
and so forth. Take responsibility for your mistakes and learn
from them.

Blaming others for your mistakes is a sure way to lose.

The term edge is borrowed from gambling theory and refers to the statistical
advantage held by the casino.

System edges
come from three components:
• Portfolio selection: The algorithms that select which
markets are valid for trading on any specific day
• Entry signals: The algorithms that determine when to buy
or sell to enter a trade
• Exit signals: The algorithms that determine when to buy or
sell to exit a trade

It is possible for an entry signal to have an edge that is significant


for the short term but not for the medium term or long term. Conversely,
it is possible to have an exit signal that has an edge for long
term systems but not for the short term. Some concrete examples
will help demonstrate this effect

Traders refer to the maximum move in the bad direction as the


maximum adverse excursion (MAE) and the maximum move in the
good direction as the maximum favorable excursion (MFE).

The E-ratio combines all of the pieces described above by using


the following formula:
1. Compute the MFE and MAE for the time frame specified.
2. Divide each of them by the ATR at entry to adjust for
volatility and normalize across markets.
3. Sum each of these values separately and divide by the total
number of signals to get the average volatility-adjusted MFE
and MAE.
4. The E-ratio is the average volatility-adjusted MFE divided
by the average volatility-adjusted MAE.

Support and resistance results from market behavior, which in


turn is caused by three cognitive biases: anchoring, recency bias,
and the disposition effect.

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