BREAKOUTS

Short-Term Patterns: Turtle Soup

by Paolo Pezzutti

Swing trading with short-term high volatility patterns can provide good opportunities for profits.
Security: N/A
Position: N/A
In their famous book, Street Smarts: High Probability Short-Term Trading Strategies, Linda Bradford
Raschke and Laurence A. Connors introduced the Turtle Soup pattern. In the 1980s, a group of traders
known as the Turtles used a trend-following system based on breakout of prices. This kind of system,
Raschke and Connors noted, can be profitable when traded on a large basket of markets, and its success
is dependent on capturing very significant trends. It's beside the point to say that the percentage of wins
is low due to the number of false breakouts and that the drawdown of the system is very large. To trade
it in the real markets, you have to strongly believe in the concepts that it applies. You must also keep
your nerve and rely on a system that sooner or later will ride the trend that will reward you for your
strong will and patience. In the meantime, this is where the Turtle Soup opportunities lie.

The aim of the pattern is to profit from false breakouts. When the trend is strong, the reversal will not
be long. However, sometimes reversals can be quite profitable. It is a typical swing trading pattern,
working well in volatile markets. The rules for buys are:
- Today, you must have a new 20-day low and the previous 20-day low has to be at
least four days earlier.

- After the new low has occurred, place an entry buy-stop five to 10 ticks above the
previous 20-day low.

The stop-loss is one tick under today's low. The authors suggest using a trailing stop for a trade that
might last a few hours or even a few days. It can be applied either on futures markets or stocks.
Normally, you should try to lock in your profits when the market makes them available.

A variation of this pattern is the "Turtle Soup Plus One." The difference is that it occurs one day later. It
benefits from the fact that many traders enter the day of the breakout on close. This way, the trap is set
up for even more traders! The rules for buys:
- The previous 20-day low has to be at least three days earlier. The close for the day
must be at or below the previous 20-day low.
 - The entry buy-stop is placed the next day at the earlier 20-day low.

The same rules apply for sell entries for both patterns, of course. Let's see how the two patterns work:

Figure 1: Turtle Soup, euros. The pattern was applied on a 60-minute chart. On April 21, 2005, at 19:00
on the euro-US dollar on the foreign exchange market, the market printed a new low with a wide range
bar. After a pullback lasted only three hours, prices went down again to new lows. This happened on
April 22, with the 04:00 bar. Prices entered back into the previous low-bar range, giving the buy signal
above 1.3024. Trailing your stop, you would have probably closed your trade about 14 hours later at
1.3072 -- the low of the inside bar (blue arrow).
Graphic provided by: TradeStation.
Figure2: Turtle Soup Plus One, oats. On December 3, 2004, in the oats futures contract, the market
printed a new 20-day high. After a sort of bullish triangle lasted 13 days, prices closed at a new 20-day
high -- interesting enough for a trend-follower and someone who would look at chart patterns like
triangles. Bullish triangles in an uptrend show a good number of trend continuation exits (someone says
about 70%, but we have not performed statistics on that!). This day is a setup for the Turtle Soup Plus
One. The next day after a gapup open (common in these situations), prices go back into the previous
day's range giving a sell signal. Luckily, you have found here a volatility expansion, giving you very
nice profits. Depending on your exit strategy, you could have closed your trade at the close the same
day, or at the next day open (blue arrow), hoping for a gap in your favor (this turned out not to be the
case), or trailing your stop (result much depending on your choices). Prices after this short sell-off trap
resumed their uptrend to new highs soon thereafter.

Using these patterns, you can get significant gains from reversals. It is difficult to quantify the results
of the pattern, because their profitability depends at least on:
- Your money management rules

- Your discipline in applying the stop-loss

- The high-volatility environment in which the trade takes place

- Your judgment about market conditions (for example, force of the trend, volatility,
and so forth)

- The risk-opportunity balance.

In summary, it is not a mechanical system. It would be too easy and there would be too many rich
people around if you could find your way to riches applying a couple of simple rules in a mechanical
fashion.
Moreover, many times it will happen that you will be stopped out because of the market noise or some
engineered move and then the market goes again your way.

The pattern has its validity and its statistical value. Looking for particular conditions like the ones used
for these two patterns (or, for example, the other well-known pattern called 80-20, also by Raschke and
Connors), you will note that to the retest of the x-day high does not follow also a close above it. It
means that most of the times, the markets tend at least to retrace from these significant levels. And
here, you can find a profit opportunity.