Saturday, 2 July 2016

The startling 80-20 rule

The 80-20 rule, a.k.a. the Pareto principle, states that roughly 80% of the effects come from 20% of the causes. For example, in business, 20% of customers equal 80% of sales, or you could say 80% of the profit comes from 20% of customers. 

I analysed my past transactions from different angles. My winning trades account for 57% of the total trades while losing trades stand at 43%. This is a bit surprise to me, because I always thought I lost more. It is now clear to me, that I magnify my losses and minify my victories, such that I self-blaming when losing, and feel nothing but want to earn more when winning -- an unconscious action (I can talk about this ceaselessly, but this is not the main point of this article).

Another thing I found startling is that 80% of the amount won comes from only 20% of the winning trades. Similarly, 80% of the amount lost comes from 20% of the losing trades. To make things clear, let say I profited RM 100K in 20 winning trades. Then, the 80K profit (80% of 100K) comes from only 4 winning trades (20% of the total winning trade). The rest 20K comes from 16 winning trades. The same applies to the losing trades. 

What a surprise.. Really?

The big question is: SO WHAT?

On the winning trades, focusing on the potential top 20% will boost the profit significantly. If the company is doing good, then just let the profit runs. On the other hand, limiting the losing trades, i.e., cut lose when necessary will prevent further losses. This will ensure that the losing trade will not belong to the top 20% that contributes to the significant loss. However, cut loss is something people don't like to do. I think the main reason is that cut loss means admitting our own mistake, and people always find it hard to admit their own mistakes (another unconscious action). But my past transactions have come down to this startling 80-20 rule. Thus, in the future, I will keep in mind of this

You are welcome to do your own analysis to find out if your past transactions follow this amazing rule.