Applying the Highly Effective 80/20 Principle in Forex Trading

The 80/20 Principle is a very effective concept in achieving efficiency.

It allows you to focus on core revenue making activities instead of wasting resources on unimportant tasks. The principle is one of the most essential concepts in modern day business and it has the same value for Forex trading.

This blog post discusses what the 80/20 Principle means, why it is so effective, and how Forex traders can benefit from it.

I highly recommend actually reading the post instead of scanning it. Information overload is rampant in our modern society and we are not used to focusing on any topic for longer than 30 seconds…

But the 80/20 Principle is an enormous time saver so if you spend 10 minutes now it will have an endless return in the future: a good example of great reward (life time saving of time) to risk (5-10 min of reading).

80/20 PRINCIPLE EXPLAINED

The 80/20 Principle is often named differently such as: the 80/20 Rule, The Pareto Law, the Pareto Principle, and others. The rule was discovered in 1897 by the Italian economist Vilfredo Pareto.

The pattern underlying the 80/20 Principle is that the distribution of results is predictably unbalanced. The 80/20 rule states that 20% of the input will create 80% of the results (output).

Put in different words: 20% of the resources will create 80% of the success.

Image 8020 P

Input/resources could be time, money, effort, skill, etc that a project, person or business puts into achieving goals. Output/success could be anything: profit, revenue, membership count, customer satisfaction, etc.

The main point is that the numbers are highly unbalanced. Humans tend to think that each unit of effort or resource has (almost) an equal importance in achieving success but the 80/20 Principle clearly explains that the numbers are highly skewed. Probability theory explains that it is “virtually impossible […] for the 80/20 Principle to occur randomly.” (Source: the 80/20 Principle by Richard Koch, page 13)

The 80/20 balance is not fixed and 80/20 numbers are examples. The ratios could be different: 30% of the resources generate 70% of the success. In fact they don’t have to add up to 100 either: 5% of the profit could derive from 50% of the customers, 75% of the revenue stems from 25% of the products, or 65% of our achievements are based on 20% of our efforts.

Last but not least, what is the importance of the 80/20 Principle? The significance for businesses is absolutely stunning. The value of knowing that, for instance, 90% of your revenues and 85% of your products are generated by 22% of your customers is enormous. The owner or manager can then allocate sufficient resources, time and energy to this group. Deeper analysis however is always needed. For instance, there could be a future customer that has a potential of generating big business. The 80/20 Principle helps with knowing what is happening NOW and what/where a business should investigate, but deeper analysis is required before conclusions are made.

For more information, examples, usages, and argumentation of the 80/20 Principle, I highly recommend reading the book 80/20 Principle by Richard Koch, who explains why the 80/20 Rule is valuable and how it can used for business, our personal lives and personal efficiency.

80/20 PRINCIPLE IN TRADING

Forex traders can use the 80/20 Principle too! In fact there is almost an infinite number of ways for how Forex traders can apply the analysis from the 80/20 Principle. The 80-20 rule not only holds true for the analysis of our P & L account but for a wide range of topics.

Number 1: trading performance. Traders can analyze these relationships:

  • Are the majority of losing trades caused by the same mistake?
  • Are the majority of losses coming from a few trades?
  • Are the majority of losses coming from a small number of days?
  • The same questions can be asked for profits and winning trades as well.

Number 2: individual performance (personal effectiveness). Traders can analyze these relationships:

  • How much time is spent on each task and how much benefit does it bring?
  • What are the crucial tasks in my trading that lead to the most results?
  • What actions are the most beneficial for my results?

Number 3: the market. Traders can analyze these relationships:

  • 80% of the time the market is in the middle of a move (not reversing), whereas 20% of the time the market is forming a top or bottom.
  • 80% of the time the market is not trending and 20% of the time it is trending;
  • 80% of the market moves are noise, 20% of the market moves are an actual signal;
  • 80% of the time the market is in a consolidation and 20% of the time it is in an impulse.

Number 4: strategy performance. Traders can analyze these relationships:

  • Do the majority of the trading opportunities occur at the same points during the strategy?
  • Are the majority of my wins generated by a minority of the same entry type?
  • Do the majority of my filters have very small impact on the performance?
  • Do a minority of my tools and indicators have the most positive impact on the strategy?

It is important to note that the Pareto principle can help traders with understanding their own performance9- 1- 2015 8020 P and the market’s movement in more depth.

The above questions and ideas are just examples. Everyone is highly encouraged to analyze and find connections that benefit you as a trader. This is not limited to the above and many more ideas can be created.

In fact we encourage you to use your thinking cap and evaluate your trading from the 80/20 Principle. Do you notice any cause and effects? What facts did you discover about your own trading when using the 80/20? Let us know down below in the comments section!

The 80/20 Principle is a golden rule as it allows us to focus on the most important and valuable core tasks, methods and resources. And focus is the only way anybody can enjoy their tasks, be in the ‘flow’ of things, learn and retain information, direct their attention for a specific goal, and valuable goals (read more in “Focus” by Daniel Goleman).

Thanks for dropping a comment down below. I would appreciate your ideas.

Happy Hunting!

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  • Chris

    Thank you! It is a great method for scanning and finding the ‘sweet’ spots indeed. Its fun as well 🙂

  • Thanks for a great article, I need to look at the 20% of my most effective areas and put my effort into those places.