Beyond the Breakout: Understanding the Nuances of Eckhardt's Entry and Exit Strategies

Breakout trading, the strategy of buying when the price exceeds a recent high or selling when it falls below a recent low, is a concept that is familiar to many traders. It is a simple and intuitive way to enter a trade in the direction of the prevailing trend. However, the Turtle Trading system, heavily influenced by William Eckhardt's quantitative approach, took this simple concept and refined it into a sophisticated and effective methodology. The nuances of their entry and exit strategies, which went far beyond a simple breakout, were a key factor in their legendary success.

The Turtles used two different breakout systems for their entries: System 1, a shorter-term system based on a 20-day breakout, and System 2, a longer-term system based on a 55-day breakout. The choice of which system to use was left to the discretion of the individual Turtle, but the rules for each were strict and non-negotiable. System 2 was the simpler of the two: a trade was entered every time a 55-day breakout occurred. System 1, however, had a clever filter designed to improve its performance. A 20-day breakout was only taken if the previous System 1 breakout had been a losing trade. If the previous breakout had been a winner, the trade was skipped. This filter was designed to avoid entering a trade after a strong trend had already been established, a time when the market is more likely to reverse. This is a subtle but important point: the Turtles were not just blindly buying breakouts; they were using a set of rules to identify the breakouts with the highest probability of success.

But the Turtles' entry strategy did not stop with the initial breakout. They also had a set of rules for adding to a winning position, a technique known as pyramiding. After the initial entry, they would add to their position at ½N intervals, where N is the 20-day Average True Range. This meant that as the trend moved in their favor, they would increase their exposure, maximizing their profits on the winning trades. This is a effective concept that is often overlooked by amateur traders. The amateur is often so fearful of giving back profits that they are reluctant to add to a winning position. The professional, on the other hand, understands that the time to be aggressive is when you are right, not when you are wrong.

The exit strategy was, for many of the Turtles, the most psychologically difficult part of the system. They used a breakout-based exit, but in the opposite direction of the trade. For System 1, they would exit a long position if the price made a new 10-day low. For System 2, they would exit a long position if the price made a new 20-day low. This meant that they would often give back a significant portion of their profits before exiting a trade. This is a painful experience for any trader, but it is essential for capturing the massive trends that are the lifeblood of any trend-following system. The Turtles understood that you can never know how far a trend will run, and that the only way to capture the really big moves is to have an exit strategy that allows you to stay in the trade for as long as possible.

The relationship between the entry and exit strategies is a key aspect of the Turtle system. The long-term breakout entries are designed to get you into a trade at the beginning of a major trend, while the trailing stop-loss exits are designed to keep you in the trade for as long as the trend lasts. This is a effective combination that is designed to capture the rare but highly profitable "outlier" trades that generate the majority of the profits in a trend-following system.

In conclusion, the entry and exit strategies of the Turtle system are a evidence to the genius of Richard Dennis and William Eckhardt. They are a sophisticated and nuanced approach to breakout trading that goes far beyond the simple strategies used by most traders. They are a reminder that successful trading is not just about finding good entries; it is about having a complete, well-defined system that covers every aspect of a trade, from entry to exit.