Tim Bovee, Private Trader: Beyond Turtles and Grasshoppers: Day of the Fox

I almost botched a trade on Monday. Dumb luck intervened, and instead I earned a spectacular return in only one day.

After doing the end-zone touchdown dance, every player needs to go back to the tape, whether he scored or not, to see what went right and what could have gone better. While a 128% gain in one day is something to grin about, the fact that I almost ended up with a loss of that magnitude is something to think about.

My present trading system is based on the Turtle Trading rule set. I've modified it almost beyond recognition to account for contingencies and things that have gone wrong. But scratch below the surface just a bit, and you'll see a Turtle staring back at you.

Turtle Trading was first developed to settle a bet made by a trader named Richard Dennis, who was convinced that even rank amateurs could, with the right system, become awesomely successful traders. And it worked, in those primitive days of 1983 when sophisticated analytical tools and charts were the playthings of the pros.

The secret of Turtle Trading was a robotic following of a few simple signals. In the original version, entry was immediate when the price crossed beyond the boundary of the 55-day price channel, or the 20-day channel in an alternative version, and exit was also immediate when it crossed out of the 10-day price channel on the side opposite the trade.

The action prompted by the signal was not only immediate, it was automatic -- no questions, no exceptions. The Turtle Trading rules were much like Horace Rumpole's wife Hilda, whom he routinely referred to as "She Who Must Be Obeyed".

We live in a different world now, of course, when any private trader, no matter how small, can have at his fingertips a tool set beyond the experience of even a star professional of the early '80s futures pits.

Among the capabilities we have now, and that the early Turtle traders did not have, is the ability to see a chart of practically any resolution for any symbol on the exchanges, in real time.

When I can calculate support and resistance in a real-time chart with a fresh bar every five minutes, or even every minute, then the idea of support and resistance takes on new meaning.

When I can see the pattern of price movements over the day so far, or even over the past three hours, the concepts of trend and momentum mean something entirely different than they did to the early Turtles.

The Turtle Trading system has faults, that are readily seen on the ground. Often, the crossing of a channel boundary is indeed a reversal signal, not a true breakout. Whipsaws abound, coming with a frequency guaranteed to give the trader a serious neck ache.

Potential losses from the exit signal depend largely on the accidents of history. If the price has been trending in a shallow path, the 10-day price channel may well be slow to track a rapidly moving price. The wide gap between the channel and the price means that a sudden reversal will wipe out most or all of the gains before the exit signal is reached.

If the price has been trending steeply, then the exit signal may be so close to the price that even a very minor countertrend correction can trigger an exit, and therefore a whipsaw, as a the price quickly resumes its course.

The system also has strengths. Almost any system, strictly followed, will produce better results than haphazard trading, what I call the Grasshopper Trading system. Grasshoppers get very excited about a stock, usually about the story behind it. They jump into a position, tell all their about it, and then hang on to the position as the stock reverses course, saying plaintively, "It's a Great Stock. It will recover soon, I'm sure of it!"

The very rigidity of Turtle Trading makes it a confidence builder and a comfort. Trading is a stressful activity filled with decisions and ambiguities. A rule set that says, "Do this. Now. Don't think. Just do it", makes life less stressful and very easy.

What I'm seeking is a method of signaling somewhere between the rigid shell of the Turtle and the flightiness of the Grasshopper.

Call it the Fox Trading system. The fox is a cunning beast, always on the lookout for the best chance, but always poised to flee, based on an assessment of risk and reward. The fox doesn't obey rigid rules, but deals with conditions and events as they are right now. He (or She in Japanese folklore) is a sneak, but also a winner.

The modifications to the Turtle rules that I've made in my own trading plan point the way forward.

Readers of Private Trader will know that I screen stocks and funds through a multi-step process.

The early steps, reported in the daily "Prospects" post, are almost pure Turtle. I'm looking for symbols that have broken past their 20-day price channels. Since I'm tracking more than 1,000 symbols each day, compared to the handful tracked by the original Turtles, I do a further non-Turtle screening by looking only at symbols whose signals have been profitable more often than not in the past year.

It is in the later phase, reported in the daily "Finalist" post, that things get interesting. First, I have a built-in delay to help avoid whipsaws. A symbol that gives a Turtle bullish entry signal on Monday must show continued momentum to the upside in early trading on Tuesday; otherwise, it is not a trade.

And then, I do something that no self-respecting Turtle would ever do: I look at the chart, without the price channels, but with another analytical tool in mind, a framing system called Elliott wave analysis. If a quick-and-dirty application of that framing system doesn't confirm the Turtle signal, then I won't take the trade.

In other words, rather than allowing a price-channel breakout to dictate my trade, even with a delay, I exercise free will and discretion in making the final decision.

And certainly the full analyses that I write are intended to give me, and the reader, a gut feeling about the trade: Do I like it or not? Do I smile at the thought, or get a churning in my stomach? I must decide, and no system can decide for me.

Exits, on the other hand, are still pure Turtle in their rigid adherence to the signals, even if modified in some cases to reduce potential losses. For my trades that typically last a month or several, I've replaced the 10-day price channel boundary with a floating stop-loss point, and have retained the one-day delay to avoid whipsaws. But if a move beyond the stop/loss level is confirmed the next trading day, I exit the position, no questions asked.

My long-term (a year or more) signals for hedging are entirely Turtle based, as are the rules for entry from the Roll Shelf and the Watchlist.

My rules for very-short-term trades, however, require judgement for exit, in the same way as is required for entry. There's nothing at all automatic about this rule set.

The answer, I think, is to take that judgement used in entering a trade and apply it to all exits, and to my hedge rules as well.

It is easy enough, after all, to run through the charts of all of my positions every day and make a quick judgement about whether a position should be retained. I tend to use Elliott wave analysis, myself, but other criteria would certainly work, such as the classic support and resistance methods I used prior to my adoption of the Turtle Trading rules. Those methods can be used to set exit points just as readily as price channels can.

Certainly there is nothing wrong with using the Turtle method and its price channels as a shout-out, placing alerts that say, "Hey, look at me." Or, for that matter, to use other tools, such as moving averages or Bollinger bands, for that purpose.

But the final decision must, in my opinion, be made as a judgement call based on the price movements recorded in the chart, without channels or other such tools.

The governments and their generals at the outset of World War I had been forced by their technology into a Turtle Trading style of war machine. When political conditions broke down, and they decided to use military action, they had no choice but to give the signal to put in motion a rigid series of steps that could neither be modified nor halted. So the Guns of August ponderously became the chaotic trenches of France.

The war fighters of today, be it the American infantry or the non-government forces of the Islamic State, like foxes have the ability to alter their plans and actions at a moment's notice to account for reality on the ground. War-making, and the warriors who make war, have achieved an amazing level of informed suppleness in their tactics and strategies that goes a long way toward winning on the battlefield with minimum cost in casualties.

As it is with war, so it is with trading. For the trading arena is a battlefield, and the private trader's laptop, with its capabilities unimagined a few decades back, is a sophisticated tactical weapon on that battlefield.

I intend to rework my rules to bring Fox Trading to all phases of my entries and exits from positions. I'll post about the rule updates when I've completed that work.

-- Tim Bovee, Portland, Oregon, Oct. 21, 2014

References

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.