When new traders enter the markets, they’re usually anxious to start trading as soon as possible. This leads to jumping into the market even when there are greater risks. Even experienced day traders will sometimes fall into this trap due to impatience. It’s like fishing anyone who has ever fished knows that it is a waiting game. When the move comes along you will know it but in the meantime you may have to sit at your computer staring at your screen for most of the day. Greater rewards come to those willing to be patient and wait so quality is the key rather than quantity. If you haven’t heard of it yet this is where the 80/20 rule comes into play.
What is the 80/20 rule?
Simply put the 80/20 rule states that for many events, roughly 80% of the effects come from 20% of the causes. This rule also called the Pareto Principle was introduced by management consultant, Joseph Juran. The rule can be applied in many different areas such as trading, marketing, life situations etc. The theory tends to have highly accurate. For example, 80% of your anxiety may come from 20% of your problems, 80% of your skills may come from 20% of your experiences, 80% of your profits will come from 20% of your trades, etc.
Understand the flexability
The 80/20 rule is flexible, in other words for some people it might be 90/10 or 70/30. The numbers do not have to be exactly 80/20. The key to this concept is that one has to look where they are getting the best results and focus on those areas. Traders look at when and where they are picking up their winning trades and strive to focus there to gain even better results. By putting more energy into actions that make money you can expect more winning trades. Take the time to really analyze your results.
For example if 80% of your profits come from shorting the market yet you only short the market 30% of the time then a good strategy would be to increase the number of short trades you take. Focus on the areas where you see better results. Don’t focus 70% of trades on longs when they only give you a payback of 20%.
Similarly if you find that 80% of your wins come in the morning and 20% in the afternoon the logical conclusion is to trade only in the morning. As your day drags on it is clear that the afternoon is more risky for you and it really is not conductive to your productivity.
Quality not Quantity
The best way to keep track of your result is to record them, this will help you to get a clearer picture of where your strengths and weaknesses lie. You will find this data invaluable as you work to improve your trading skills. Your trade journal should include:
Date and Time
Day of the Week
Type of Trade (Long or Short)
Price of the stock
Amount of shares traded
Indicators that influenced the trade
Reason you made the Trade
Stop loss allowed
Length of the trade
Notes what you did while waiting for the trade to play out.
Record any mistakes you may have made such as ignoring your trading plan
Write down the information before the trade and immediately after the end of the trade. This information will help you beyond measure as you see patterns emerge. Becoming a trading pro requires structure and a journal will help provide that so you can eliminate guesswork. Also remember there is a need to be patient and look for the best trades and take the time to analyze your results so that you can minimize your risks and maximize your profits.