Despite the
title of this post, this is not another analogy between long-term investing and
the story of the tortoise and the hare. Instead, in the trading world a Turtle
is known as a protégé of Richard Dennis and William Eckhardt, who ran a
Commodity Trading Advisor (CTA) business in Chicago during the 1970’s and 1980’s.
These two traders conducted a trader training experiment based on disparate
opinions on whether or not trading was an innate skill or could be developed.
After the first round of successful training, another round of testing was
completed with similar results. That is, the Turtle trader trainees were able
to trade profitably using the set of rules taught by Dennis and Eckhardt. One
of the trainees was Jerry Parker who went on to found and run Chesapeake
Capital Management for the last few decades. His firm specializes in medium to
long-term Trend Following trading
principles that he learned while in the Turtle program.
In a recent
interview Parker highlighted three ways to survive in the trading game based on
his experience. Under Trend Following each of these three concepts are employed
naturally. Parker advises that traders diversify, trade with the trend, and cut
losses quickly.
First, risk
can be mitigated through diversification. This can be accomplished by trading
multiple asset classes, using different time frames, or employing unique systems.
For example, your system can have some exposure to interest rates, equities or
stock indexes, currencies, and various commodity products. Doing so will
minimize risk at different periods in the economic cycle. Additionally, you can
design a trading strategy that uses a 200-Day Simple Moving Average (SMA) to identify a long-term trend or use a 10 and
20-day SMA crossover system to delineate short-term trend direction. As a
result, you will diversify your trading time horizon. Also, you can complement
various trend methods with mean-reversion strategies.
Parker’s
second piece of advice, trading with the trend, is as old a strategy as you can
find in the market. However, it still works. Whether you believe that
macro-economic policy, fundamentals, or behavioral biases drive a market,
trends will persist. In fact, Perry Kaufman conducted five Trend Following
trading studies using a simple moving average, exponentially weighted moving
average, linearly weighted moving average, linear regression slope, and
breakout system across seventeen markets. He notes that “the first and most
significant point is that results are all profitable. That means Trend
Following works” (Trading Systems and Methods). As a trader, your job is to be
on the right side of the trend and take as much of the profit from the move as
possible. Of course, if a trend does not materialize after a false signal then
risk management becomes paramount.
Finally,
Parker advises traders to cut their losses quickly. Clearly, “quick” is
subjective and will vary by a trader’s risk tolerance and specific system
parameters needed to create positive expectancy. In other words, your gains
must be larger than your losses to have any chance of surviving in the markets.
The basic premise of Parker’s comment is that successful trading is based on
risk management policies that cut losing positions before too much damage has
been done to your account.
If you are
not doing so already, take time to reflect on how you can better execute on
these three core concepts in your trading.
As always,
please feel free to contact me with any comments or questions. Thanks for
reading.
JD
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