The 80/20 rule is also called Pareto Principle (the law of the vital few, or the principle of factor sparsity). This principle “states” that in many events, approximately 80% of the effects come from 20% of the causes.
The origin of this rule was from the observation of population and wealth. Pareto noted that 20% of the Italian population owns 80% of the country’s assets. He then made statistics in many other countries and was surprised to see the same distribution. I will take one more funny example as follows. If you put the wealth of the 3 richest people in the world (Bill Gates + Buffet + Carlos Slim) together, we have a number equal to the total assets of the remaining 7 people in the list of the 10 richest people in the world.
The 80/20 principle is very common in finance, economics, sales, and other fields. So certainly, this rule can apply to our trading. Today, I will discuss it with you.
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How do we apply the 80/20 rule in Forex trading?
With the 10-year observation of my teacher in the trading field, the 80/20 rule is not a “complete accuracy” according to science. But the meaning and efficiency that it brings about in every aspect of business are indisputable. This ratio should also be interpreted relatively. For example, we can also have 75/25, or 90/10, or even 99/1.
How many times have you heard this saying: “Only 10% of traders make money in the foreign exchange market, the remaining 90% are at a loss.”? An exact ratio between people who make money and those who lose money is hard to calculate. But I think this ratio ranges from 80/20 to 95/5.
Now the question is “Why is trading so difficult and why 80-90% of participants are losing money?”. I would like to offer my opinion as follows.
Trading is a typical job for the saying “more is not better, less is better” or “simpler is better”. However, reality shows that it is difficult for us to follow these seemingly simple “instructions”.
– 80% of transactions should be simple and easy, only 20% should be more complicated.
– 80% of the profit comes from 20% of the opened orders.
– Regarding the time spent on the market, 80% is not for opening orders. The money-making opportunities appear in the market within only 20% of the time.
– For 80% of the time, you should not have any orders in a transaction. You should only do it for the remaining 20%.
– 80% of all orders are opened based on daily candlesticks. Only 20% are of other time frames (h1, h4, w1, etc.).
– 80% of the success in trading comes from trading psychology and balance management skills (risk/profit). 20% comes from the trading strategy and system.
Now we talk more about each above bullet. I will only go briefly because regarding all the issues below, I will write about them in detail in other articles.
80% simple – 20% complicated rule when trading Forex
This is quite simple. Most of our trading work is sitting in front of a computer and observing the price movement. This work is certainly not difficult. Identifying the market is not difficult. It is also not difficult to find opportunities to enter a trade. Only people complicate these things.
I pursue the trading method following trend, level and signal (TLS strategy) because it is simple (and also effective). You do not need to know about complicated indicators. For example, sitting and counting how many Elliott waves are there or trying to explain a variety of technical information, etc. Traders are often stuck in such complicated stuff. They quickly get tired, depressed, and give up.
The difficult part about trading is to control yourself. Do not trade too much. Never risk too much on every order. Do not lose control of emotions and rush into the market after a big winning or losing order. In short, it’s to control your behavior and your mind. Along with balance management, they are considered to be the most difficult parts of trading.
Traders usually only spend 20% of their concentration time on this, while it should be 80%. I think that is also one of the most important reasons why they lose money.
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80% of the profit comes from 20% of the transactions principle
I advise you should trade like a sniper. It means waiting patiently for a reasonable chance to pull the trigger. Focus on quality trading rather than quantity trading.
The fact is clear that the money I make comes from a very modest percentage of orders. My winning order usually earns me 2 to 3 times money than the money lost from a losing order.
This way, even if the number of losing orders exceeds that of the winning orders, I still earn a decent amount of money at the end of the year. It’s the secret of the 80/20 principle.
For 80% of the time, I DO NOT trade – For the remaining 20%, I MAY trade
On average, I open about 4 orders a month. It is understandable because I am very careful when choosing to open an order. I think you should do it too. I don’t like venturing my hard-earned cash for something that is unclear and unobvious.
Most traders prefer the style of trading a lot and continuously. This makes them think that they will make money both more and faster. This leads to the situation that 80-90% of participants are losing money. They lose money because they trade too much.
Meanwhile, the opportunities that the market “gives” us are certainly not that many. They do not have enough patience and discipline to wait for a truly clear opportunity. If you have also been trading stock for years, sit back and watch over the years. How many profitable opportunities does the market give us a year? Or how many waves does a year have? The answer is a few times only.
Do you see a correlation between the percentage of losing traders and the time without opportunities on the market? They are all around 80%. The market mainly fluctuates in a given (narrow) band. Most of the time, the price movement (up or down) brings no value to traders.
My mission is to analyze price movements, then stay patient and disciplined. I need to wait until the market really gives me the opportunity, rather than jump into an unclear market which fluctuates up and down in a narrow band. This is the most important point that I want to discuss in this article.
Don’t turn yourself into a drunk guy who throws money at betting on casinos. Remember that 80% of the time on the market is not for trading; only 20% of the time is appropriate for making a trade. If you think you’re trading 80% of the time, then stop, consider, think and change this habit. About 80% of that time, we spend on observation and “preying”.
80% of orders are based on daily charts (D1) – Only 20% are of other time charts
This is my favorite part of the 80/20 rule. The daily chart is my “weapon” of choice. 80% of my trades are based on daily candles.
I find that most traders trade with lower time frames (h4, h1, m30, etc.) and most of them are at a loss. People are attracted to quick movements or dancing numbers in low time frames. It creates an “addictive” impact, which makes traders constantly open orders. And that is why they lose money.
80% of the success in trading comes from trading psychology and capital management skills. 20% comes from the trading strategy and method
This is another example of 80/20 principle. You should spend 80% of your time and energy on learning psychological control and capital management skills. For the remaining 20%, you can spend it on chart analysis and trading.
If you trust and persevere with this, I am confident that you will see significant changes in the way you trade. You will feel more secure, safer, more comfortable, and of course, make more money.
Many traders never realize this. The reason is that they go all in trying to find a strategy or a method to help them earn 1 million dollars in a short time. And if the current method does not help them earn money, they will find another method. That circle just keeps repeating.
In conclusion
Do you often review your transaction history?
I have saved all my trading history even from my first accounts. Yes, I have lots of accounts, lots of “dead” accounts.
Just take a look at those losing orders. How many orders did you open when you let your emotions overwhelm? How many orders did you open as if you were gambling a game of chance? Does it follow the 80/20 principle with 80% lose and only 20% win?
We can eliminate 80% of our losing orders by not letting emotions overwhelm our trading decisions, can’t we?
Focus your energy and mind on the things that earn you money (the 20%), not the other 80%. Work less, but smarter. What you need is a simple trading strategy and method. This is to eliminate the emotional effect as much as possible by not spending too much time (I only look at the chart a few times a day, and no more than 5 minutes each time).
P/S: Please don’t be impatient. I’m still trying to take the time to share everything I’ve learned with you here.
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The post How To Use 80/20 Rule or Pareto Principle In Forex Trading appeared first on How To Trade Blog.
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