Stock Market Strategy: Pareto Principle
Trading on the financial market is no exception. In this case, every investor adopts an entire series of specialized approaches and rules for generating better results, such as strategies, plans, and money management guidelines just to name a few. That being said, other than specialized rules, more universally-applicable approaches can create the ideal conditions for trading financial assets. This article will examine the 80/20 rule, also known as the Pareto principle, and how it can be applied in a trading context.
If you were to consider this principle in a wider context, it is worth noting that the basic concept is present in every sphere of life, from health and wellness to economics and finance. The universality of the rule and the ability to utilize it as a tool for improvement has made this approach very popular in various fields of economic, marketing, and financial research.
The 80/20 is sometimes known as the Pareto principle. This was originally an observation made by Vilfredo Pareto that around 80 percent of the world’s wealth is only owned by 20 percent of the population.
It is like sports. You have to be only one-100th of a second ahead of the next person to win the gold medal. Indeed, if you look at the finishers in a race at the Olympics, you will probably find that the difference between the top five or seven people would be around one-100th of a second. Still one gets the gold and many others, nothing. Over the years, it has been seen that the same person or team keeps on winning the gold year after year. It is not as though they are vastly superior to the others around them – just a wee bit.
Even in the market, the winners get most of the gains. It is not as though they are better than you are. This ‘winners take all’ situation typically occurs in relative comparison, where your performance relative to those around you is the determining factor of your success.
The market being a collective, your relative performance counts a great deal, as your money comes from the other participants. Any decision that involves using a limited resource like time or money will naturally result in a winner-take-all situation. And, time and money are extremely limited resources in the market.
The 80-20 rule is an excellent method for improving efficiency.
So, financial trading is first and foremost statistics and numbers that are used by traders to generate forecasts and develop strategies. Therefore, it is unsurprising that the statistical 80/20 rule has been widely adopted in this field.
It is likely that many traders noticed that they don’t always trade as effectively. A simple example of this is that 20% of trading contracts produce 80% of a trader’s profit. And, of course, many know that only 10-20% of those trading on the market achieve success, the rest lose their capital. Of course, this is the most basic example that demonstrates how effective this rule can be.
More such examples of the prevalence of the rule in the stock markets are - Market conditions are only good for effective trading 20% of the time, the remaining 80% of the time the market is unsuitable for trading, effective traders are only on the market 20% of the time, the rest of the time they devote to other matters, Only 20% of contracts lead to 80% of profit, statistically 80% of trades placed are simple, the remaining 20% are complex, 80% of trading takes place during the day, and 20% in other timeframes, 80% of a trader’s success is down to psychological factors, and analysis and strategy only make up 20%, 20% of readily-available forecasting tools are effective at market analysis, the remaining 80% of tools don’t give you any useful information, the quality of a technical forecast is 80% down to the analysis of macroeconomic statistics and news and only 20% reliant on technical market data.
Despite the quality or performance of the strategy, for the vast majority of traders, only 20% of their contracts lead to an increase in capital. The reason for this is not only down to technical trading signals, but purely statistics as well. As we already mentioned before, the market is only ideal for trading 20% of the time, meaning that contracts opened at the right times perform best financially. On this basis, first and foremost, without taking into account the level of predictability of the market when a seemingly accurate trading signal has been received, the risk factors of a contract are increased, meaning the level of possible profit.
By using the basic 80/20 rule when determining your financial plans, you will not only correctly and effectively manage your own funds, but also create the possibility of improving your trading results. To put it simply, it isn’t worth pursuing trading positions for little profit, trade patiently under the right conditions and your signals will increase without a doubt!
The primary trading issue in terms of profit hinges on stability generating accurate trading forecasts. The problem is that the market is chaotic and only forms a clear pattern of rate movement that can be forecasted through specialized tools and approaches 20% of the time. More than likely, all active traders have noticed through observing chart liquidity throughout the day that they can only form relatively few effective trading positions. Other than that, no trading system generates signals stability anytime during the day. All of this is caused by a myriad of factors, the leading of which is macroeconomic drivers and the statistical of traders’ activity, such as total capital, the number of market participants, and interest in any given asset. Of these forms the necessary conditions for applying the basic 80/20 rule.
To put it simply, the market conditions are only ideal for trading 80% of the time. This brings to mind a statistic of successful traders that only 80-90% of investors can achieve success on the market, the rest just lose money.
Many online traders on the financial market try to trade actively despite the 80/20 rule and time management, meaning that the quality of their forecasts and general trading signals decreases significantly. As follows, a large number of contracts placed based on questionable forecasts lead to capital loss, not gain. Consequently, this can be resolved entirely logically using one basic rule, trading is a field where “if you do less, but to a higher standard, you will profit more financially”!
When deciding on an effective time management regime that meets your needs, you should never forget about the 80/20 rule. This will not only help you set up the best trading conditions for you but also increase how effective your trading operations are. Other than that, this trading regime allows you to spend minimal time and achieve better trading signals.
Typically, online traders prefer to trade over minimal chart rate periods. It is completely clear why as this leads to more dynamic trading within a 24-hour period. At first glance, such a trading regime appears to be more interesting and lucrative. However, when keeping in mind the 80/20 rule we know that quantity does not equal quality, the opposite is true. And this is why.
By analysing timeframes shorter than daily, traders significantly decrease their scope for analysing the market, therefore decreasing the quality of forecasts. The reason for this is technical. The issue is that the shorter chart liquidity timeframes, the higher the level of market noise, significantly influencing the effectiveness of any strategy.
Moreover, shorter timeframes demonstrate more chaotic fluctuations which are difficult to analyse. As a result, they can lead to losses. In contrast, day charts enable you to see a wider picture of the market, which undoubtedly increases how effectively you trade. This leads to an increase in the market trends forecasted, better pattern identification, and more accurate trading signals.
On the basis of this, you could say that the 80/20 rule applied in such a way is an indispensable tool for improving how effectively you trade. For practice, we recommend that you adopt the following approach to trading operations: 80% of the time work on a daily asset liquidity chart, and 20% of the time work on an hour or minute timeframes. However, when you are generating forecasts on shorter timeframes, take into account the overall signals from the daily charts.
So as to ensure that you apply the 80/20 rule effectively when trading on the financial market, you can conduct your own simple experiment, examine your own trading statistics over various periods. Without a doubt, you will notice a basic pattern: 80% of your contracts will be losing, 20% will produce peak profit. This will be true of every indicator as well, from the risk level to the choice of the optimum time to trade and the cost-benefit of market analysis. Don’t waste your time-fighting nature and mathematics, learn to harness it!
So, the 80/20 rule, as you can see, is very effective for trading on the financial market. If you closely follow this approach for increasing how effectively you trade, then you can improve your trading results by the end of this year.
In conclusion, it is worth mentioning that the full potential of the 80/20 rule as it applies to financial trading has yet to be uncovered. That being said, we can speak to the popularity of it and the great potential it has for other applications in the future.
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