Way of the turtle

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Way of the Turtle

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seven
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.
A
key question, perhaps the only question, to ask when you are
considering a system-based trading strategy or trying to select
a fund advisor who uses such a strategy is: “How can you know
whether a system or a manager is a good one?” In general, the
answers the industry offers are various takes on the following: The
strategy or manager with the highest risk/reward ratio.
Everyone wants to make the most money for a specific level
of risk or incur the least risk for a particular level of expected
return. On this point we are almost all in agreement: traders,
investors, fund operators, and so forth. Unfortunately, there are
many different opinions on the best measures of the risk and
reward parts of the risk/reward ratio. Sometimes the financial
industry defines risk in such a way that the description com-
pletely blinds it to certain kinds of risks, and those risks are just
as likely to bite them in the ass as are the ones with which they
do concern themselves.
Copyright © 2007 by Curtis M. Faith. Click here for terms of use. 

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The large losses incurred in the implosion of Long-Term Capital
Management are a good example of risks that existed outside the tra-
ditional measures. This chapter will review those risks and ways to
account for them, and then propose some general mechanisms for
estimating risk and reward for trading systems by using historical data. 
Rich and Bill were very concerned with the size of our positions
because they knew that there was a risk of losing their entire net
worth if those positions were too large during a large adverse price
movement. A few years before starting the Turtle program, they had
traded during a period when the silver market was locked down
limit for days and days. This meant that there was no opportunity
to exit because there were no traders willing to buy within the lim-
its imposed by the COMEX futures exchange on how much the
price of silver could change in a single day. This is the futures
trader’s worst nightmare. Each day you are losing more and more
money and there is nothing you can do about it. 
Fortunately, Rich was able to trim his position before this occurred,
and that probably saved him tens of millions of dollars. If he had not
acted quickly, he would have lost everything. I am sure the memory
of that move was vivid in their minds during the Turtle program.
Rich constantly monitored the Turtles’ positions and sometimes
would reduce his own positions if he felt that the aggregate risk was
too great. Contrary to the popular notion that Rich was sometimes
a gunslinger, in my experience he was very careful with his risk.