Donchian Channel Strategy – The Turtle System

In this Indicator Spotlight, we’re looking at a donchian channel strategy. The Donchian Channel indicator was originally developed by Richard Donchian. Is a trend-following approach and was famously used by the Turtle Traders in their system. To learn more, watch the video or continue reading below.

The story about the Turtle Traders originated from a discussion between famous commodities trader Richard Dennis and his long-time friend Bill Eckhardt on whether great traders are born or made. Eckhardt was convinced that certain a “trader type” character was the determining factor, whereas Dennis thought this was a skill that could be taught.

In order to find out, they advertised for trading apprentices and trained a group of about 23 people with no trading experience. The group learned the rules of a simple trend following system over the course of 2 weeks. Upon demonstrating that they could follow the rules, participants were funded between \$200K and \$2 million. A wide range of commodities, currencies, and bond markets would be traded. When the experiment ended five years later, the Turtles had reportedly returned a profit of \$175 million, making it the most famous experiment in trading history.

Two Donchian Channel Strategies:

The Turtle Traderdonchian channel strategy entered when prices broke out of the channel in two separate timeframes. System 1 looked for a breakout from the 20 day high/low, whereas System 2 used a 55 day high/low breakout. For System 1, one would skip a signal if the previous trade was profitable, whereas all signals of System 2 would be followed.

One may locate the Donchian Channel lines by using the highest high and lowest low over the lookback period (System 1 with a 20 days high/low channel above). Our Donchian Channel version also allows for calculating the channel lines by using the Open, Close, Median, Typical or Weightedprice. You may then identify breakouts to either one side of the channel lines, rendering the bullish, bearish and neutral trend states.

A green plot will indicate that the highest high of the lookback period has broken whereas a red plot indicates a break of the lowest low. A neutral trend, as indicated by a yellow plot, occurs when the price retraces beyond the channel midline.

Position Size and Scaling In:

Again, the main idea for thedonchian channel strategy is not to predict price movements, but simply to follow them. To that end our version also come with fast, slow and composite trend definitions. In the chart below we see the fast trend definition on a 4 hour Chart of the NQ for System 2 (55 bar high/low). The fast filter allows the trend definition to trigger a few bars earlier than for the 55 bar breakout.

The Turtles applied strict rules for position sizing and scaling into thedonchian channel strategy. No single trade would risk more than 2% of the available capital. Initially, one would only commit a fractional amount of the intended position size. By a favorable move, one would then add to the position, eventually reaching max position size. In the above example, one could open a position on the fast channel breakout and add to it at the System 2 breakout.

The benefit of this approach is that on false breakouts, positions will be relatively small (not the full position size). In the case of a strong breakout, one may apply a maximum position size to fully capitalize on winning trades.

Exit Management:

The Turtledonchian channel strategy Exits were said to be the most challenging part of the rules. In the chart below we see a gray 20 bar high/low channel added to the 55 bar high/low. The 20 bar low would mark exits for long positions and a 20 bar high exits for short positions. One would then close the entire position if the price went against that level. For System 1, the exit condition would be a break of the 10 bar high/low.

Waiting for these levels to hit, often meant giving back significant, if not all of the open profits. There was of course a strong tendency to take earlier exits. However, in order for the system to work, it was necessary to stay in the positions, waiting for the next windfall move.

Conclusion:

Following the experiment, the rules of the system were published and performance dropped significantly. Richard Dennis continued to manage capital but stopped doing so following heavy losses in the Black Monday stock market crash of 1987 and later in 1988.  He later managed funds in the mid and late 1990s, closing these operations after losses in the summer of 2000.

A number of Turtle Traders continued their careers as successful commodity trading managers, using similar, but not identical techniques to the Turtle Donchian Channel System. You will find the original rules, as set out by Richard Dennis, here.

Other Channel Indicators available from our NinjaTrader Indicator Library category include the Daily Regression ChannelMACD BB Lines, Projection Bands, Raff ChannelSqueeze Channel, Multiple Bollinger Bands and many more.