If you’re at all interested in investing or trading its highly likely you will have, at some point, seen an advert promising a trading method that will earn you a fortune. There are over 41,000 results when searching for the word “trading” on Amazon. To put it mildly, it isn’t hard to find a strategy to trade pretty much anything. But can you do it better than a rat? How about a turtle?
Last week I read an article explaining an experiment undertaken by conceptual artist Michael Marcovici:
“For the project, Marcovici trained dozens of rats to detect patterns in the foreign-exchange futures market. To do this, he converted price fluctuations into a series of notes played on a piano—if a price went up, the next note was higher—and then left it up to the rat to predict the tone of the note that followed. With some prodding, the rats began forecasting price changes.”
Marcovici had surprisingly positive outcomes. Having cross-bred the four most successful rats from the initial group, he ended up with a second generation rat with a 57% accuracy rate on his “trades”. Obviously the process wasn’t entirely scientifically accurate, and whilst there is some allusion to recorded data, it hasn’t been explicitly provided (to my knowledge). What can we learn from this undertaking?
Marcovici wanted to demonstrate that the job of trading need not necessarily require the involvement of a human to be successful. He surmised that trading requires two things: 1. An ability to recognise patterns and 2. An ability to avoid distractions.
As important as it is to have an effective trading/investing strategy, it is equally important to maintain the discipline to stick with it. Legendary trader Richard Dennis was so certain his strategies were effective he implemented the Turtle experiment in the 80’s, just to prove that anybody could be taught how to trade.
The Turtle Experiment
Dennis became part of trading folklore during the 1980’s, turning an initial $5,000 stake into over $100m trading futures markets. Due to his success (and a belief anyone could do it), he proposed taking respondents from an ad in the Wall Street Journal and training them up using his strategies over a two-week period. And this is the important part, the strategy. Dennis knew it had worked for him, and he was adamant it would work for his students. The only difference was in whether they had the correct mental disposition to stick with it.
Staking his own money on these “turtles” by funding their accounts to the tune of $1m, Dennis made approximately $175m over five years from his students. Some dropped out, some weren’t successful. But those that were earned him a fortune, and a few even went out on their own as a result of what they’d learned. But not all were successful as a result. Former turtles Jerry Parker and Michael Shannon reputedly made money after leaving the program, but others failed as a result of not being able to stick to the rules they were taught. Rules detailing how to think about:
- Position sizing (how much to risk on a trade)
- Entry and exit points (when to get in and out)
- Setting a stop loss (limiting your losses on a trade)
If you’d like to read more about Dennis, the turtles and his experiment, I highly recommend the below books:
Click either link to view in Amazon
Whilst much of the experience remains shrouded in mystery, there are lessons we can take away from it.
Having a System
The system worked. But without effective rules it was doomed to failure. This was what some of the turtles struggled with. Trading requires rules. It requires the mechanisation of the system, removing all element of human biases and “superior” judgement. Removal of the influence of outside agencies, of all the noise we hear and read about companies and markets. Above all, it requires faith in the system. There is no one way to make money in markets, either in trading or investing. But there is one way to lose it. By forgetting your principles and getting distracted.
I maintain this view in investing, and I am, at heart, a long-term buy and hold investor. I prefer to do rigorous analysis initially to identify a company I feel will grow and succeed over time, and then buy at an attractive valuation. Knowing this means accepting that success will not come overnight. It means attempting to avoid checking my portfolio every day (something I personally struggle with) because I know one week, or one month won’t be the difference.
I know what I’m looking for in a company. I also know what to avoid, which companies to immediately discard from my searches and screens. As with trading, my investing has a system. This system may change from time to time as I incorporate new information and develop my knowledge, but fundamentally I stick to it, without fail. Having a system also means missing out on big winners. One example recently is of clothing retailer Boohoo.com (BOO), up approximately 258% in the past twelve months. A staggering result for holders of this company, and with some promise of future growth they may yet be rewarded further.
As of writing, however, Boohoo.com sits on a price/earnings ratio of around 74. A price to book ratio of 17.4. A price to sales ratio of 6. In short, it’s expensive. With a compound annual growth rate since listing of around 30%, however, this valuation may be worth it. But it’s not part of my strategy and therefore I discard it without question. It is necessary to do this for no other reason than to protect me from myself, to protect me from getting distracted. Protect me from succumbing to jealousy and greed and losing sight of my strategy. In short, to be more like a rat. It’s how bubbles are avoided. Just ask Sir Isaac Newton: