The 80/20 rule In Trading. How To Implement It?

How do we get the 80/20 rule?

Before we discuss how the principle works, let’s first take a look at how it was first conceived by Vilfredo Pareto.

Vilfredo Pareto, an Italian economist, developed the 80/20 rule in 1906. He discovered that 20% of the pea pods in a field yielded 80% of the harvested peas. He then extrapolated that idea and calculated that 20% of Italy’s people owned 80% of the land. After examining several other nations, he discovered that the same was also true elsewhere.

Pareto principle

What's the 80/20 rule in trading?

The Pareto principle is a basic statement on inequality, and can be applied to many different fields. For example, the 80-20 rule can be applied to assume that 20% of your efforts make 80% of your account’s growth in trading.

Let’s take a look at some key stats where we can see this principle applied in trading:

• Only 20% of trades generate 80% of the profit.
• 80% of your winning trades depend on 20% of market analysis.
• 80% of long-term trading and 20% of short-term trading.
• You need to be in a trade 20%, in 80% not so.
• Your success depends on 20% of your approach and 80% psychology.

We’ll next examine each of these claims in detail.

1. Only 20% of trades generate 80% of the profit

According to experts, you should only select the best trades. However, in the beginning, it’s natural to want to close a large number of trades and make a rapid profit. It’s therefore a good idea to check your trade log to see how 80/20 generally works.

The principle means that more of your trades will be losers than winners, but that the winning trades are the most important for your profit margin. You have to go in strong and make a nice chunk of change on the trade.

If it goes in your favor, you make some cool pips. You have to trade with patience and precision. Remember that the winning trades will follow from proper risk management.

Applying the 80/20 rule in trading

2. 80% of your winning trades depend on 20% of market analysis.

We frequently spend too much time examining the market, searching for indicators, trends, and patterns. As a result of overanalyzing, subjectivity emerges – we start looking for signs that validate our assumptions, rather than what the market is actually telling us.

The trading strategy you use doesn’t require a complex algorithm. Leave the market to do all the work and don’t overtrade. Pro traders tend to spend less of their time and focus on other aspects of trading. They spend about 20% and use 80% of their market research.

3. 80% of long-term trading and 20% of short-term trading

Trading on a daily timeline and building profits over time demonstrates the trader’s success. It increases his/her trust in the trading system and trading style. I don’t know a single billionaire who made his money through scalping.

All successful traders traded or shifted to a longer timeframe at some point. But I advise you to open a small account for day trading, because it can help you foresee the market momentum during the day.

Note that traders generally lose money when trading on smaller time frames, which fits well with the 80/20 rule – 20% of traders focus on larger timeframes. They are the ones that make the real dough.

4. You need to be in a trade 20%, 80% out

The essence of pro trading is not to overtrade. Many pro traders may take positions only 4 or 5 times. I’m choosy in my trading style; I don’t trade too often and don’t open trades at every move. I don’t like to risk more than 1% on my trades.

80% of profits come from 20%

Many traders try their hand in algorithmic trading or high-frequency trading. These styles allow you to open multiple positions during the day. Now, I’m not saying these trading styles are wrong. But as a beginner, you can’t rely on these methods. They are exclusively for pro traders… When novice traders attempt them, they lose money.

It’s worth noting that learning is the best way to aid in this process. Studying the market and examining different strategies can help you have 20% of profitable trades.

5. Your success depends on 20% of your approach and 80% on your psychology

Ask any professional trader what the most difficult aspect of trading is, and they’ll tell you: controlling your emotions. You can’t have 100% control over the market, but you do have control over your risk management and your trading psychology.

Strategy is important, but psychology is more important. If you read any trading book, the author will usually mention trading psychology first. It’s important to have control over yourself and focus objectively on the process.

Pro tips for the 80/20 rule

Now that you know all about the 80/20 rule in trading, it’s time to give some pro tips.

When applying the 80/20 rule, you have to remember the nature of the market. The market moves in cycles. This means that when things are going your way, you shouldn’t suddenly change up your trading strategy. Don’t force yourself to trade each day or every hour.

Back off from trading when you don’t feel like it. I know it’s hard to only trade 20% of the time when things are going your way, but trust me, big gains come when you don’t trade too often.

In the end, it’s all about having more winning trades, and trading too often can start creating more and more losing trades. There are going to be long periods when you are simply treading water. The key is to not let impatience and frustration during those periods affect you – that leads to poor decision-making.

Many traders use take-profit, but they generally don’t consider the 80/20 rule. The great value of profit targets is that they are motivational. However, your ability to meet them varies greatly as the market goes through its cycles. It is important to keep pressing when you have a strong run of gains, and take advantage of whatever the conditions might be helping.

Still, don’t forget that it won’t last forever. Cycles and the 80/20 rule will come into play again. If you are not making progress, then don’t trade at all. Leave trading alone for a while. Come back when you are ready for the market cycles. Learn more interesting facts about forex.

FAQs

1. How did we come to know about the 80/20 rule?

Vilfredo Pareto, an Italian economist, developed the 80/20 rule while studying the land distribution of the country. Later, the 80/20 rule fitted in every business and financial trading.

2. How to apply the 80/20 rule?

Applying the 80/20 rule isn’t complex. It’s not like you have to put any mathematical formula on the chart. You just have to remember the key stats when applying the 80/20 rule.

3. Can I apply the 80/20 rule in any market?

Yes. The good thing about the 80/20 rule is you can apply it in any market, whether forex, stock, options or even the crypto market. You can trade with the rule without a hiccup.

4. Does the 80/20 rule work?

The success of the 80/20 rule depends on the trader. You have to stay patient, control your emotions, and apply proper risk management if you want the 80/20 rule to work.

5. Is the 80/20 rule suitable for any strategy?

Yes, 80/20 applies to every strategy. However, as I mentioned earlier, the rule becomes more effective when you trade on larger time frames. According to the rule, 80% of long-term trading results in a significant sum.

Final thoughts

The 80/20 rule is a good addition to your trading strategy. It’s easy to understand, and anyone can keep it in mind while trading; remember the pro tips I mentioned earlier, and apply them to your trades.