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The Importance of Position Sizing

Diversification is an attempt to spread risk across many instruments and to increase the opportunity for profit by   increasing the opportunities for catching successful trades. To properly diversify requires making similar if not   identical bets on many different instruments.

The Turtle System used market volatility to measure the risk involved in each market. We then used this risk   measurement to build positions in increments that represented a constant amount of risk (or volatility). This   enhanced the benefits of diversification, and increased the likelihood that winning trades would offset losing trades.

Note that this diversification is much harder to achieve when using insufficient trading capital. Consider the   above example if a $100,000 account had been used. The unit size would have been a single contract, since 1.688   truncates to 1. For smaller accounts, the granularity of adjustment is too large, and this greatly reduces the   effectiveness of diversification.

Units as a measure of Risk

Since the Turtles used the Unit as the base measure for position size, and since those units were volatility risk   adjusted, the Unit was a measure of both the risk of a position, and of the entire portfolio of positions.

The Turtles were given risk management rules that limited the number of Units that we could maintain at any   given time, on four different levels. In essence, these rules controlled the total risk that a trader could carry, and   these limits minimized losses during prolonged losing periods, as well as during extraordinary price movements.   An example of an extraordinary price movement was the day after the October, 1987 stock market crash. The U.S. Federal Reserve lowered interest rates by several percentage points overnight to boost the confidence of the stock market and the country. The Turtles were loaded long in interest rate futures: Eurodollars, TBills and Bonds. The losses the following day were enormous. In some cases, 20% to 40% of account equity was lost in a   single day. But these losses would have been correspondingly higher without the maximum position limits.

The limits were:

Level Type Maximum Units

1 Single Market 4 Units

2 Closely Correlated Markets 6 Units

3 Loosely Correlated Markets 10 Units

4 Single Direction Long or Short 12 Units

Single Markets A maximum of four Units per market.

Closely Correlated Markets For markets that were closely correlated there could be a maximum of 6 Units in   one particular direction (i.e.6 long units or 6 short units). Closely correlated markets include: heating oil and   crude oil; gold and silver; Swiss franc and Deutschmark; TBill and Eurodollar, etc.

Loosely Correlated Markets For loosely correlated markets, there could be a maximum of 10 Units in one   particular direction. Loosely correlated markets included: gold and copper; silver and copper, and many grain   combinations that the Turtles did not trade because of positions limits.

Single Direction The maximum number of total Units in one direction long or short was 12 Units. Thus, one   could theoretically have had 12 Units long and 12 Units short at the same time.

The Turtles used the term loaded to represent having the maximum permitted number of Units for a given risk level. Thus, “loaded in yen” meant having the maximum 4 units of Japanese Yen contracts. Completely loaded meant having 12 Units. Etc.

Adjusting Trading Size

There will be times when the market does not trend for many months. During these times, it is possible to lose a   significant percentage of the equity of the account. After large winning trades close out, one might want to   increase the size of the equity used to compute position size.

The Turtles did not trade normal accounts with a running balance based on the initial equity. We were given   notional accounts with a starting equity of zero and a specific account size. For example, many Turtles received a   notional account size of $1,000,000 when we first started trading in February, 1983. This account size was then   adjusted each year at the beginning of the year. It was adjusted up or down depending on the success of the   trader as measured subjectively by Rich. The increase/decrease typically represented something close to the   addition of the gains or losses that were made in the account during the preceding year.

The Turtles were instructed to decrease the size of the notional account by 20% each time we went down 10%   of the original account. So if a Turtle trading a $1,000,000 account was ever was down 10%, or $100,000, we   would then begin trading as if we had a $800,000 account until such time as we reached the yearly starting equity.   If we lost another 10% (10% of $800,000 or $80,000 for a total loss of $180,000) we were to reduce the account   size by another 20% for a notional account size of $640,000. There are other, perhaps better strategies for   reducing or increasing equity as the account goes up or down. These are simply the rules that the Turtles used.