The 80/20 rule, also known as the Pareto principle, states that 80% of the effects come from 20% of the causes. This can be applied to many areas of life, including Forex trading. In this article, we’ll explain what it means and how you can apply it to your forex trading strategy so you can maximize your profits by focusing on the right trades.
What is the 80/20 rule in forex trading?
The Pareto Principle, also known as the 80/20 rule, states that 20% of your efforts will generate 80% of your results. This translates to the belief that 20% of positions or trades will account for most gains in forex trading.
The rule enables investors to determine which trades they should concentrate on to maximize their profits. It is sometimes difficult to determine the exact activity that determines an individual trader’s success or failure because several factors almost always affect the outcome.
What is the 80/20 Rule
The Pareto Principle, also known as the 80/20 rule, was coined by Italian economist Vilfredo Pareto. His research found that eighty percent of wealth was controlled by 20% of Italy’s population at the time.
In other words, 20% of what you do yields 80% of your desired result. In a business setting, this could mean doing a few tasks every day instead of all. By focusing on the most important tasks and ignoring the less-important ones, we can be more productive and achieve our goals more quicker.
It’s an easy concept to apply to any area of life – if you want to increase your results by 30%, then focus on only 30% of what you currently do and ignore 70%. If it takes 100 hours to complete a task, then only work for 30 hours and see how much more efficient that makes things!
Can the 80/20 Rule Work in Forex
This rule was not devised for forex. However, it can be applied to other areas of life, including forex. It is also regarded as a profitable strategy for making more money. According to this rule, in forex, you can generate 80% results by putting in only 20% of the effort. In simple words, it means cutting the efforts to generate bigger rewards.
Many traders do the mistake of overtrading. They think that in this way they can earn more. The reality is different trading more than five pips a day can make you fall victim of greed. Trading too much does not mean too much effort. Instead, putting small effort into getting a large return is the outcome of the 80/20 rule.
How to Apply the 80/20 Rule in Forex: 5 Ways
To apply this rule in forex, you need to consider a few essential things:
Don’t go for scalping or short-term trading. It happens with day traders who set short terms profit goals. To achieve these goals, they trade frequently. It mostly does not go in their favor. The reason is that random volatility balance loses and gains.
- The rule of 20/30 will work only when you trade on clear chart patterns. If you trade on trend breakage at the support and resistance line you can surely get 80% out of 20% efforts.
- The risk-reward ratio should be set properly at least 20% for risk.
- Never invest in more than one pair or open random positions to diversify your portfolio. It will not only increase the risk-reward ratio but also decrease your account capital.
- It is better to go for long-term trading to achieve consistent profit. It will also reduce your effort and time.
- If you follow the above 5 ways and keep your emotions under control, you can surely generate 80% out of 20%. But never ignore the leverage factor!
80/20 Trading Strategy in Forex
The Pareto principle in forex trading also known as the 80-20 rule also applies to how much money you make on your trades. You see, for some people, the law of the vital few also applies to trades. 20% of your trades account for 80% of your total profits, and this 20% can actually net 5-10 pips.
The other two-thirds of your trades may not produce much. It is true that they are not high-risk investments. They do not provide a high-profit potential. As a result, the best way to use this principle is by carefully managing risk so that you can profit from big wins and prevent losses if things go wrong.
Role of Leverage in 80/20 Rule Forex
Traders follow different strategies when it comes to leverage. They may decide to use high leverage and invest a relatively small amount to generate higher returns on investment (ROI).
Others may opt for low leverage and use less money with more margin room, hoping their investments provide a higher ROI than would otherwise be possible with other options.
Regardless of which strategy you choose, remember that all investors are subject to losses on some percentage of their portfolio at any given time. When deciding how much risk you want to take on with your investments, remember that it’s better to keep your losses small than try for huge wins and risk losing everything in one trade.
Drawbacks of the 80/20 Rule in Forex
For forex traders, the rule has some drawbacks.
- For example, if your money management discipline is poor, and you are prone to losing a lot of money on a single trade, it may not be ideal.
- Another drawback of using this rule incorrectly can be excess trades and funds being locked up, which will diminish its effectiveness.
- Therefore, before making an investment or trading decision based on such a rule, think carefully about the appropriateness of the rule to your investment objectives and style.
The Pareto Principle seem to work well in everyday life. However, in forex, it requires high command n trading knowledge and experience to make 80% out of 20% efforts. This principle’s fundamental concept is that not all types of efforts or investments (input) produce output.
In other words, while you cannot control everything and have some luck on your side sometimes, a vast majority of our success in life can be attributed to what we put into it. Blindly following rules can confuse you. So upgrade your trading skills and then apply rules like this!