APPLYING THE 80-20 PRINCIPLE TO TRADING

Posted: 2010-06-01

Contributing Author: Ruth Barrons Roosevelt

What is the 80-20 Principle? It was discovered by Vilfredo Paretto many years ago in 1897. He discovered that patterns of wealth in income remain consistent through time and place. No matter what countries or time periods you looked at, you would find that 20% of the population would have 80% of the wealth. The proportionate imbalance of income remains true today despite current political efforts to redistribute wealth.

The 80-20 principle occurs in other areas as well as income. Simply put, people get 80% of their positive results from 20% of their efforts. For example, 20% of products produce 80% of profits. 20% of customers and 20% of salespeople produce 80% of sales. Ineffective efforts produce a similar disproportion. 80% of negative results come from 20% of behaviors. 20% of incompetent drivers cause 80% of accidents. 20% of students cause 80% of classroom disruption just as 20% of students receive 80% of honors.

Take time to analyze your own actions, theories, and time spent; and you may be surprised to discover that a relatively small proportion of your own efforts produce a large majority of your positive results. Conversely, 80% of your troubles come from 20% of attitudes and actions.

It’s an amazing proposition: The vital few of people, ideas, time, and behaviors create 80% of success; while the trivial many of people, efforts, concepts, and time allotted create 20% of desired results. Negative actions, attitudes, and ideas demonstrate the same percentages of unwanted and wanted results.

Take this principle over into your trading analysis and you may be thrilled to discover that 20% of your setups produce 80% of your profits. Furthermore, you may be able to identify the 20% of your trades or trading behaviors that produce 80% of your losses. Look further into the stocks or futures or other tradable instruments that do or don’t produce significant profits. Examine the times of day when there are favorable odds—and this is all it is—probabilities lining up for or against you. Look at the days of the week, the days of the months, and the seasons to identify whether or not there is an edge.

Keep looking. Look at successful traders. What is it that they do that produces their enormous profits? What don’t they do?

What are you doing that works? How can you do more of that? What are you doing that doesn’t work? How can you stop doing that?

Perhaps most importantly, what do you need to believe to get the absolute most from your trading day and life?