The Pareto principle is an important basis for success in many areas of activity, including the forex market. Its study is also included in educational programs at many universities around the world.
This principle helps to correctly allocate your own capital, time and other resources in order to increase the efficiency of your business development and achieve maximum results. The basic concept is that everyone can spend less energy and effort, but get much better results. To do this, you just need to focus on the 20% of the most important factors that give 80% of the result.
The origin of Pareto principle
"80% of all wealth belongs to 20% of the population" - this is how the concept was originally formulated. This pattern was noticed at the end of the 19th century by the sociologist-economist of Italian origin Wilfredo Pareto. And in the middle of the twentieth century, the American engineer Joseph Juran proposed his concept of a universal principle that is found in a variety of fields: "20% of efforts give 80% of the result, and the remaining 80% of efforts — only 20% of the result."
The 80/20 principle is one of the most rational and effective concepts for achieving maximum productivity. In fact, it reflects the uneven distribution of causes and effects. And instead of spending resources on non-essential tasks, you can focus on the main activity that generates income. This is one of the most important concepts of modern business. It also has a high value in the context of Forex trading.
It is worth paying attention to the fact that 80/20 is not always strictly accurate figures, they only reflect the essence of the fact that the first indicator is always significantly higher than the second. And sometimes these values can deviate in one direction or the other, for example, 90/10 or 70/30.
Application of the Pareto principle in various fields
The "80/20" rule has found application in business management and startup development.
- 20% of the company's customers account for 80% of sales;
- 20% of employees are responsible for 80% of the results;
- in project management, many managers note that the first 20% of the effort gives 80% of the success in the future.
So the 80/20 rule can help managers and business owners focus their potential on the really important things.
Also last year, an interesting study was conducted, the object of which was Nigeria. According to many indicators, in the mid-noughties, this state was relatively rich (for its region), and had a high potential for increasing the well-being of the population. But experts have found that, since 2006, the situation has not changed in any way. 76% of the country's residents continue to live below the poverty line, and the remaining part-accumulate almost all the national wealth, as it was before.
In investing, the 80/20 rule usually means that:
- 20% of assets generate 80% of portfolio revenue;
- on the other hand, 20% of assets can bring 80% of losses.
But there is an alternative method: try to focus the portfolio on those 20% of the shares in the broader market that make up 80% of the market return. However, due to the uncertainty of potential revenue, this method is difficult to apply in practice. Stocks are inherently risky assets due to the unpredictability of future results.
One method of using the 80/20 rule when filling a portfolio is to form 80% of the portfolio's assets in less volatile investments, such as indexes or funds. And invest the remaining 20% in risky shares. Then 80% of lower-risk investments will bring reasonable security, and 20% of higher-risk assets, according to positive forecasts, will provide good growth.
Basic rules for successful traders
Based on the Pareto principle, you can formulate basic principles that will help novice traders in the early stages of interaction with the market:
- 20% of the trades will bring you 80% of the profit, and 80% of the trades will bring you only 20% of the profit.
- For 20% of the time spent on trading, you will earn 80% of the income, and for the remaining 80% of the time, you will only get 20% of the profit.
In general, the rules are quite simple and effective. The most difficult thing is to comply with them. If most stock market players used the Pareto principle in practical trading, they could increase their performance indicators and enter the top 20% of traders.
The above statements serve only as examples. But based on them, each trader can analyze different aspects of their trading from the 80/20 principle perspective. That is, in any case, it is extremely important to use your own experience.
The 80/20 principle in analytics
There are many ways where traders can apply the 80/20 principle. This rule applies not only to the analysis of the profit and loss statement, but also to many other aspects of trading.
According to the Pareto principle, the following indicators can be traced:
- What causes most of the losses?
- Is the majority of losing trades the result of repeating the same mistake?
- Are most of the losses accounted for by several transactions?
According to the Pareto principle, you can analyze such parameters of personal effectiveness:
- How much time is spent on each task and what benefits does it bring?
- What are the key tasks that lead to maximum results in trading?
- What actions are most useful in achieving the desired results?
From the point of view of the broad market, Pareto principle points to the following patterns:
- 80% of market movements are noise, and 20% are a real signal to open a trade;
- 80% of the time, the market is in a state of consolidation, and 20% - in momentum.
In the same way, you can analyze the effectiveness of the selected strategy. For example, 20% of open trades bring 80% of the profit, and the remaining 80% of trades are closed at zero or with a slight deviation in either direction. It is also important to note that the Pareto principle can help traders better understand their own results and the dynamics of the market.
According to the Pareto principle, you can derive several rules that will maximize the efficiency of trading:
- If 80% of the working time is spent inefficiently, you need to find weak points and minimize them in order to focus on performing tasks that ensure results.
- If many different tasks are set when drawing up a trading plan, it is better to select and complete only 20% of the most important ones.
- If you do not have enough time to study the market and trade, then most likely, 80% of the "interfering" cases can be abandoned without much damage.
- 80% of the information about trading, which is littered with the Internet, only clogs the brain. After obtaining a certain amount of knowledge, the value of further study decreases.
- Only the practice of trading for real money provides the development of 80% of trading skills.
Psychology in trading
Proper self-control is the most important factor of success in trading. To get a stable profit, you need to control your emotions and soberly assess the situation, instead of succumbing to general panic.
Therefore, it is the development of such qualities that should be given 80% of the time. And the remaining 20% should be devoted to active trading. At the same time, it is important to choose the right strategy, and follow it in all circumstances. Here again, you can recall the rule that 80% of market movements are noise, and you need to trade in the remaining 20% of the time.
Thus, the right psychological attitude allows you to choose priorities correctly. That is, perform only those actions that are necessary to obtain maximum profit, which in the future will lead to success.
The 80/20 principle is the golden rule of the trader. It allows you to focus on the most important and valuable, fundamental tasks, strategies and methods. Focus is the only way to get total satisfaction from successfully completed tasks, to be in the "flow", to study and save information, as well as to direct your attention to specific goals.