Relating 80/20 Rule and 3M (Mind, Money, Method) in Your Trading

I have just finished reading The 4-Hour Workweek, a bestseller book by Tim Ferris. One of his many interesting theories that struck me was the use of the 80/20 rule. This rule, also known as Pareto's Law  is applied in business studies, sales, economy and many other endeavors. Today, I am going to illustrate how the 80-20 rule can help optimize your trading and boost your trading profits.

Pareto's Law can be summarized as follow: 80% of the outputs result fro 20% of the inputs. To put it in different ways, Tim Ferris gives more examples in his book:

1. 80% of the consequences flow from 20% of the causes.
2. 80% of the results come from 20% of the effort and time.
3. 80% of the company profits come from 20% of the products and customers.
4. 80% of all stock market gains are realized by 20% of the investors and 20% of an individual portfolio.

One important thing to note is that the ratio is often skewed even more severely such as 90/10, 95/5, 99/1 are also common, bu the minimum ratio to seek is 80/20.

How this Law is related to trading?

Trading in general consists of the 3M - Mind, Money, Method. Mind is basically how you manage your emotions and understand the psychology of trading. Money is the position sizing system so that you can manage the risk and survive in the trading business. Method is the strategy to buy and sell stocks. 

For most traders out there, there is one thing that matters the most: the trading system. Trading system research and developing new strategies for trading are their main focus, but mostly this is about looking for that holy grail of trading systems. Their argument is that while I do like to apply money management and discipline/psychology, about 80% of what I do is test new trading systems and look for new methods. That leaves 20% for money management and trading psychology & discipline.

The truth is, to make profits in trading, one does not need to have the most accurate system in the world. What is needed is really a good system executed with discipline and using proper money management methods. I strongly believe that trading psychology + money management are the 20% which is responsible for 80% of trading success.

So, to relate the 80/20 rule, I would like to summarize this way..

1. Instead of researching and keep updating/changing your Method (I am not saying it is not important), spend more time in understanding the trading psychology and position sizing.
2. As 80% of your profits are coming from your top 20% trades, focus on the market movement and make sure you do not miss the boat when the market is uptrending.

Happy trading and happy holiday!