The Pareto principle in trading

In the modern world, mass media constantly point to the fact that most of the money belongs to a relatively small number of people. The same is about stock trading - most traders lose their money and only 10-20% of the total mass have a steady income. Why it happens? There is no only true answer to this question. Nevertheless, some economists and “gurus” of trading apply for the so-called Pareto principle. In this article, we will consider which pillars this rule is based on and how it relates to Forex trading.

According to official sources, the Pareto Principle was named after the economist and sociologist Vilfredo Pareto, who was born in Paris in 1848, but was Italian by nationality. From 1906, he began to notice certain economic patterns. For example, he noted that 80% of the land in Italy belonged to 20% of the population. Then, he formulated the principle, noting that 20% of the pods in his garden contained 80% of the peas. These and other regularities led to the fact that Vilfredo Pareto developed the “80/20 Rule”, which in general form looked as follows: 80% of the effects come from 20% of the causes.

Many stock traders admit that this classic rule works well in trading. We can give the following examples of how you can use the “80/20 rule” in stock trading:

- 80% of transactions should be fairly simple and only 20% of transactions should be difficult;

- 80% of all profits are made from 20% of transactions;

- 80% of your time you need to be out of the market, you should not trade every hour and every day, it is enough to spend 20% of the time for trading;

- 80% of the signals for opening a position should arrive from week and day charts, since they have a stronger tendency, and only 20% of the signals for opening a position should arrive from shorter time frames;

- 80% of success in stock trading is the result of strict discipline and strict risk management, and only 20% of success is due to the trading strategy.

As you can see, the rules are quite simple and effective. The most difficult thing is to follow these rules. If the majority of exchange players used the Pareto principle in practical trading, they could have better results than 20% of successful traders and 80% of unlucky traders.