Using the Pareto principle in trading

[It's Snake Pliskin]

On another thread I saw some comments regarding using the Pareto principle in trading. So how does it apply to trading and who allows for it?

 

[Kryzz]

Is it fair to say that the Pareto principle is taken advantage of in the equities market primarily, as opposed to other commodities/derivative markets etc?

 

[Trembling Hand]

Did i just travel to a parallel universe.

Anyway I'm with you snake. How do you apply it? If its actually something that can be applied rather than just an explanation of distribution.

 

[tech/a]

T/H ------But you dont know which trade is going to be the trade which brings home 15R.

Tech-------Correct and its the big R multiples you want.
This is what I do in my own discretionary trading.

(1) I set very tight initial stops I dont want to be trapped in the no mans land of trade triggered stop in tact trade is doing nothing.
I also get a much tighter R/R. and potentially quicker larger R/Rs.

(2) I get out of exponential trades as quick as I price indicates (3 min charts tell the story at tops).
My own personal stat search indicates around 50% of trades which move 30% in a day will come off tommorow.
50% moves have even higher and 100% close to 80% come off so sell at close or near to it has proven wise.

(3) Those which move pause and move into a range are cut.
I have a formula I use to move stops in ranging stocks.

Just a matter of standing in front of and staying on board Trains!

 

[Whiskers]

On another thread I saw some comments regarding using the Pareto principle in trading. So how does it apply to trading and who allows for it?

Is it fair to say that the Pareto principle is taken advantage of in the equities market primarily, as opposed to other commodities/derivative markets etc?

The Pareto principle (also known as the 80-20 rule,[1] the law of the vital few, and the principle of factor sparsity) states that, for many events, roughly 80% of the effects come from 20% of the causes.[2][3] Business management thinker Joseph M. Juran suggested the principle and named it after Italian economist Vilfredo Pareto, who observed in 1906 that 80% of the land in Italy was owned by 20% of the population; he developed the principle by observing that 20% of the pea pods in his garden contained 80% of the peas.[3] It is a common rule of thumb in business; e.g., "80% of your sales come from 20% of your clients." http://en.wikipedia.org/wiki/Pareto_principle

Maybe it's just me, but I think many people use the principle/rule at least to some extent, without even realising it.

Lobbyists target those few people who control the decision making, rather than an indiscriminate group off the street.

Researchers/plant and animal breeders identify products/plant and animal varieties with sought after characteristicts, ignore the rest, to improve their prospects of producing better products/plant and animal strains

Yield investors select sub groups of companies/investments with the best history/prospect of high yields and ignore the rest... similarly capital gain etc.

If you want to buy large tracts of land in Italy, cost effectively, find the 20%... those who control large tracts of land as opposed to indiscriminately dealing with the first people you come across.

That's basically how I understand and use the principle... and ditto for your investing/trading system rules, indicators and management.

In short cull the less relevant and less effective and focus on your selected 'Train' (as Tech/a puts it) with a stratergy to essentially lock in as much profit/gain as you can.

But, to refer to a problem mentioned again in a segment on Catalyst on the ABC last night, where company boards are increasingly appointing 'Psychopaths' to high level decision making often to the detriment of the company... because the company staff 'selection criteria' seeks out go getters, influental high achievers. Just the stuff that Psychopaths excel at and companies inadvertantly appoint... to the later expense of staff moral, customer relations and further down the line, turnover and profits.

I suppose the moral of the story is to beware that we might select and install a 'psychopath' in our system, literally or figuretively... and bugga-up our pareto principle.

 

[tech/a]

Whiskers.

Your right.
We no longer do small projects not because we cant but we can produce much more chargable Square meters/day with the same infrastructure.
Up to 5X.
Profit goes exponential!

 

[ginar]

Maybe this Pareto principle will work for a lot of traders . im sure that those who accept mediocrity in successful trade ratios need to work very hard on the top 20% of trades as thats possibly where ALL their profit is .

 

[ginar]

Maybe this Pareto principle will work for a lot of traders . im sure that those who accept mediocrity in successful trade ratios need to work very hard on the top 20% of trades as thats possibly where ALL their profit is .

And if anyone actually fits this bill i suggest you forget the Pareto principle and just work on method . Sometimes all this intellectual snobbery gets in the way of what really isnt that complicated . Trading is defining probabilty and managing possibility . Working on those 2 is all i concern myself with

 

[marknz88]

My understanding was that profitable traders make 80% of their profit, from 20% of their total trades...

I dont really think you can apply the principal any other way really? Happy to be proved wrong.

 

[yonnie]

dont know anything about the Pareto thing, but what I`m reading here it means nothing more than cutting your losses short and letting your profits run.

I agree with Ginar: just get the most out of your trades.

but not all share trading comes under this heading...........mine is not and I still make a very good profit.
probably comes close to scalping.

 

[Trembling Hand]

In short cull the less relevant and less effective and focus on your selected 'Train' (as Tech/a puts it) with a strategy to essentially lock in as much profit/gain as you can.

Of course that ignores the fact that markets do not offer the same all the time. And that is one reason people Blow up. looking for 10 R winners when there is only 2r on the table then take 3R when 10 R was there.

Its fine stepping away when the runners are not available but I think over the long run you are better just adapting to what the market is offering.

 

[weird]

Interesting research paper by Blackstar funds,

"The Capitalism Distribution" Research Paper

http://www.blackstarfunds.com/files/TheCapitalismDistribution.pdf

 

[tech/a]

Of course that ignores the fact that markets do not offer the same all the time. And that is one reason people Blow up. looking for 10 R winners when there is only 2r on the table then take 3R when 10 R was there.

Its fine stepping away when the runners are not available but I think over the long run you are better just adapting to what the market is offering.

Hmm
You can't do both?
You don't take a larger R multiple if it's there?
Sure you can do well with 80% win rate and low R
I wouldn't write off applying the principle in trading.
More than one way to post a profit.

 

[Trembling Hand]

I wouldn't write off applying the principle in trading.

You haven't showed how to use the principle. Its not rocket science to say that if the markets moving let it run, its also not application of Pareto principle.

The bottom line is if you take a historical set of trades and somehow find what sets up the top 20% and then only trade that you are only going to have 20% of your historical profit, probably as a best case. It is likely that just because you had 20 outliers in your last 100 trades your chasing random conditions.

 

[weird]

You haven't showed how to use the principle. Its not rocket science to say that if the markets moving let it run, its also not application of Pareto principle.

The bottom line is if you take a historical set of trades and somehow find what sets up the top 20% and then only trade that you are only going to have 20% of your historical profit, probably as a best case. It is likely that just because you had 20 outliers in your last 100 trades your chasing random conditions.

T/H, I think Tech/A has mentioned within prior posts in this tread, cutting losers, letting the winners run ... those large multiple R fall in the top 20-25% percent.

I don't believe Tech was alluding at trying to find those 20% only, but making oneself available to them, by trading the full 100% ... and cutting losers. This is Trend Following 101, I trade a system which uses profit targets, but raises stops aggressively ... hence the name Belayer, such as used in rock climbing ... this system will never have outliers or very very few.

Many different ways to trade.

 

[nunthewiser]

Many different ways to trade.

BINGO!

sorry for lack of content post but that needed to be said for those that dont believe in anything other than there way.

 

[tech/a]

T/H, I think Tech/A has mentioned within prior posts in this tread, cutting losers, letting the winners run ... those large multiple R fall in the top 20-25% percent.

I don't believe Tech was alluding at trying to find those 20% only, but making oneself available to them, by trading the full 100% ... and cutting losers. This is Trend Following 101, I trade a system which uses profit targets, but raises stops aggressively ... hence the name Belayer, such as used in rock climbing ... this system will never have outliers or very very few.

Many different ways to trade.

All I can do is set myself for high R multiple trades.
I have no idea if the next trade sill be in my top 20%
but I do know that if a true outlier comes along my R multiple won't
be high it will be spectacular.
For someone who advocates the stupidity of attempting
to be right you certainly seem he'll bent on insisting how I
can be right in finding my top 20%
ain't going to happen I'm not interested in being right just around for
those rare blackswans

 

[weird]

All I can do is set myself for high R multiple trades.
I have no idea if the next trade sill be in my top 20%
but I do know that if a true outlier comes along my R multiple won't
be high it will be spectacular.
For someone who advocates the stupidity of attempting
to be right you certainly seem he'll bent on insisting how I
can be right in finding my top 20%
ain't going to happen I'm not interested in being right just around for
those rare blackswans

Tech, I assume some of those comments were not directed to me.

I have been friends with Tech/A for over 5 years, he trades, just like T/H ... they perhaps trade differently, not sure why there is a sparring match between them atm. I respect both traders.

 

[Trembling Hand]

All I can do is set myself for high R multiple trades.
I have no idea if the next trade sill be in my top 20%
but I do know that if a true outlier comes along my R multiple won't
be high it will be spectacular.
For someone who advocates the stupidity of attempting
to be right you certainly seem he'll bent on insisting how I
can be right in finding my top 20%
ain't going to happen I'm not interested in being right just around for
those rare blackswans

LOL tech you are a joke.

You are kidding yourself if you think that you actually apply Pareto principle.

You Don't Apply it. Its just the distribution of profit.

 

[tech/a]

No------- T/H