In this post, I quote from the book The 80/20 Principle to explain what it means. I also explain how it relates to trading (wins vs. losses + patience) and quote from Unknown Market Wizards to give examples.
The 80/20 Principle:
The book The 80/20 Principle was written by Richard Koch. By building on the Pareto Principle, Koch explores how a small number of inputs leads to the majority of outcomes. He also shows how identifying and focusing on your highest-impact actions helps you achieve much better results in business and life while doing less work.
From the book, Koch explains the 80/20 Principle as follows:
The 80/20 Principle asserts that a minority of causes, inputs or effort usually lead to a majority of the results, outputs or rewards. Taken literally, this means that, for example, 80 per cent of what you achieve in your job comes from 20 per cent of the time spent. Thus for all practical purposes, four-fifths of the effort – a dominant part of it – is largely irrelevant. This is contrary to what people normally expect.
The quote can’t be any more clearer: 20% of what you do produces 80% of the results. Koch also notes that the split doesn’t have to be exactly 80/20—the ratio can be slightly higher or lower. Don’t get too caught up in the exact numbers, just remember: the vast majority of results come from a minority of inputs.
Next, I quote from 2 Market Wizards, demonstrating how The 80/20 Principle plays out in trading.
Unknown Market Wizards and Quotes:
In Unknown Market Wizards, Jack D. Schwager interviews exceptional traders who achieved massive success while operating mostly under the radar. Unlike Wall Street executives or famous hedge fund managers, these are everyday individual traders, trading their own accounts from home or small offices. Unknown Market Wizards is the fifth installment in the Market Wizards series, and as with the others, the focus is on risk management, patience, and discipline while achieving big returns.
When Peter Brandt – a trader of classical chart patterns and a trading career spanning more than 50 years – was asked about the importance of placing asymmetrical trades, knowing that they have around a 50-50 chance of working, he answered:
I think that’s a good description. All my profits come from 10%-15% of my trades; all the other trades are throwaways. The same pattern seems to hold consistently year in and year out. The problem, of course, is that I never know which trades are going to be in that 10%-15%.
Amrit Sall, a.k.a, The Unicorn Sniper, is a futures trader with a 337% annual compound return over 13 years. When he was asked about how difficult it can be to sit on your hands and wait for setups, part of his answer was:
One of the mistakes I made in those early years was that when nothing was going on, I forced marginal trades, wasting mental and financial capital, instead of waiting for the unicorn that will eventually show up. Learning from that mistake was one of the pivotal lessons in my trading career. I now know that 90% of the time, the market is not going to provide any opportunities, and 10 % of the time, I will make 90% of my profits.
For both of these traders, a huge percentage of their profits comes from a very small amount of their trades. I explore more on this next.
Wins, Losses, Patience and the 80/20 Principle:
Making 80% of your profits from 20% of your trades doesn’t necessarily mean that 20% will be winners and 80% will be losers, but it does mean you shouldn’t expect a trading strategy with an extremely high win rate (unless you are scalping).
There will always be winners and losers. Depending on your trading style, strategy, and trade management, there will also be breakeven trades, small winners, and small losses—trades that don’t move the needle much and don’t contribute significantly to your PnL.
The goal should be to identify which setups contribute to that 80% of your profits and slowly weed out the subpar ones. How do you do that? By journalling and reviewing all your trades, and then having the patience to sit and wait for those high-quality setups.
Does this mean every trade will suddenly turn into a winner? No, we can never predict the outcome of any single trade. But it does mean that over a large enough number of trades, your overall results should show remarkable improvement
Finally:
The solution to your success as a trader is easy. Track your trades, find which ones produce the vast amount of your profits, then have the patience to wait for them.
Thanks so much for reading. All the best with your trading.
Thanks and Regards,
Trading SOS SOS
