Using Pareto’s 80:20 rule to boost your trading profits

 

Well, I finally took the plunge…

After being pestered to death by my two boys (8 and 6) I bought a laptop for them to do their homework on…

Of course, this can be roughly translated into boy-speak as: ‘Play as many games as we can get away and do a bit of homework when we get nagged enough!’

Now, I must be honest, I’m not a raging computer fanatic.

I mean, they’re great if you use them as a tool. If they serve a specific purpose like keeping in touch via email, or if they let you do something you just couldn’t do otherwise (can you imagine trying to hand-draw two-minute candlestick charts in real time?) but they always seem to run away with your time don’t they?

There’s always some feature, or a certain app, or a special piece of software that you don’t need to use right now but you end up learning about anyway. You know: just in case it comes in handy some day…

Before you know it an hour of video tutorials and note taking has whizzed by and it’s questionable whether the light will ever be worth the candle.

I don’t really like it – but it’s the world they’re growing up in.

With my boys, their tablets were bad enough. They’d connect up to each other and play a game called Minecraft. They’d spend hours on it (complete with blazing rows over who had knocked the other one’s wall over, or who’d let the digital pigs out of their pen) but tablet use has now been restricted to school holidays only, so that’s not so much a problem now.

And I must say, I do find it strangely depressing to walk into a room and find them glued to those little screens, but I guess that’s the world they’re growing up in.

So I figured, with the laptop, if they really do enjoy spending time connected up, at least they can be encouraged to learn a bit of coding and create some simple games rather than mindlessly playing them. Or learn how to build basic websites. It’ll all come in useful for them someday, I’m sure.

So imagine my horror when I fired up the new laptop, ready to start their computer education, only to be greeted by the strange new world of Windows 8!

This was going to be like learning a foreign language.

If you’ve not seen it yourself it’s the latest operating system from Microsoft. And it’s like nothing I’ve encountered before. I think it was designed with touch-screen devices in mind, so it’s all based on blocky tiles that you click on. I found it totally counter-intuitive to begin with (I’m getting my head round it a bit now).

It didn’t help when I’d got two excited boys jumping up and down, issuing instructions. “Let’s have a look at CBBC online, dad.” And, “How do you see what the football scores are, dad?” Honestly, I couldn’t even work out how to navigate my way around at first. So frustrating!

“Hang on, boys. Let me look in the book.”

(I’m not that daft, I did buy a copy of Windows 8 for Dummies at the same time as the computer!)

So, after a couple of hours messing around and customising the laptop until I found it vaguely usable, we were in business!

I didn’t waste time learning all the fancy ins and outs of Microsoft’s latest showpiece, I just needed to get all the basics close to hand: how to get on the Internet, how to open a Word document (for that all important homework), how to download photos from a camera – you know the kind of stuff.

Here’s where you apply the Law of the Vital Few…

Now, all this flapping around like a stranded fish did bring recollections of something called the ‘Pareto Principle‘ to mind. Have you heard of it? It’s also known as the ’80–20 rule’.

The idea is that generally, in many varied fields, 80% of the results can be achieved from 20% of the options available…

• 80% of a company’s sales tend to come through 20% of its product lines.

• 80% of a football team’s goals might be scored by 20% of its players.

• 80% of software functionality can come through 20% of its features…

So whilst cautiously eying-up the 416-page Windows 8 for Dummies, I started thinking: “Well, I know I can get 80% usability of this computer from 84 of those pages. And I’ll bet I can break-it down again too. I reckon 17 of those 80 pages will give me all the essential nuts and bolts to get me up and running.”

And it was true: they did. The key is of course, finding which of those 17 pages to pay most attention to in the first place!

So here’s how you can use the Pareto Principle as a short-cut to learning any new skill…

You can still spend time later going over the small nuances, but the essential 20% is what’s going to get you up and running fast and still give you 80% efficiency!

For this example, let’s choose a trading theme. I’ve got a bit of a thing for good old Point & Figure charts at the moment (more to come on that in weeks to follow), so let’s say you were a trader wanting to start using P&F from a standing start. How might you use the 80–20 rule to get up and running quickly?

Sell Signals on a Point & Figure chart

Example: Learning Point & Figure with the Pareto Principle

1) Break the skill down into its component parts. The first thing you’d need to do is look at all the pieces that make up the whole process you’re trying to learn.

With trading stuff it might be how to draw the charts, how to interpret the signals etc… It’s easy to do with trading methods because there is so much educational material available.

Just buy a couple of well-regarded books or training courses on the area you’re interested in. You’ll find it’s all already been broken down for you!


2) Select the 20% to concentrate on. Next, you’d need a way of filtering out the essential parts that’ll give you 80% of the results you’re looking for. That might be something you do by researching top-performers in the field, taking note of the things they do in common, and focusing hard on those common elements of success.

You might already have an idea of what 80% of the results will look like (I did with the computer) and in that case you can whittle your reference material down accordingly.

But with something like Point & Figure charts, you can go one better. There is already a wealth of research done into the effectiveness of entry and exit signals. There’s even a book called The Complete Guide to Point-and-Figure Charting that breaks down the profitability of the different signals in great detail.

So you could simply make a start with the 20% of the most profitable patterns they’ve already identified!


3) Get moving! Apply your refined selection of building blocks. Take your 20% selection from step 2 and get to work testing. Apply the entry and exit patterns to your chosen market, run a backtest (easy to do manually with P&F charts) and see if you can’t notch up 80% of the optimised results through 20% of the trades.

It might need a bit of tweaking and fine-tuning but the motto here is to move fast and refine quickly. If you do want develop a new skill you’ll do it so much faster by simply getting into action and forget about meticulously learning the non-essentials. You can do that later, if you still think you need to at all.

What do you think? Is there a trading approach or method you’d like to learn? Why not share your thoughts on the Trader’s Nest forum? We’ll all get to work on it together and see if we can’t boil it all down to the essential 20%!

Be Prepared: Market Moving Data Coming This Week (London Time).

Right, I’m off to learn the essential 20% of our new parental control software. I need to keep those boys away from any dodgy websites!

Until next time, happy trading!