Podcast – Episode 132 – The 80-20 Trader
One of my 12 month books is called the 80-20 principle by Richard Koch. Now, a 12-month book is one of the 12 books that I read every year. So every month, I’ll have one of these books, read it, and then I’ll implement. And these are books that have special lessons for me, stuff that I need to implement. Stuff that I want to work on, for the whole year. And what I used to do is, I used to read a lot of books I still do. I’m a Book Reader, I love reading books, I love reading, learning, but I don’t implement as much as I should.
So even though there’s so many things in here, so many ideas, so many stories, so many, so many examples, I don’t implement them in a way that it actually helps me. So I’m reading, re-reading, and I’m getting pleasure out of reading, but I’m not implementing, so it’s not really making my life much better. And so I implemented this process where I would read one book, and then implement it for a month, and then read another one implement it at the end of the year, I go back to the first book, because there’s probably more stuff in there that I can use. So if I finally finished one, I got everything out of it, then I’ll replace it. But I’ve been on the same 12 books for a while now. Now I said one of those 12 books is the 8020 principle. And so the 8020 principle is something that I need to work on. And in fact, you probably all work on it. That’s why I keep going through it over and over again. Now, this weekend, I was at the library with my kids getting them some books, and I came across this book, the 8020 manager by Richard Koch now, this guy’s really milking this 8020 thing. I mean, he’s he’s gotten, I don’t know, like eight or nine books on it, probably, I have I owe like three of them. And then he’s got this way. And who knows how many more? So yeah, he’s really honing in niching, down, right 80% of his income come from the 8020. So the 8020 principle is also known as The Pareto principle. And you’ve probably heard of that one before you, you kind of have an idea what I’m talking about. William Pareto was an Italian economist, who lived way back then, I don’t know when he lived. I’m not a historian. So you can Google it if you want to end he discovered while doing some research that 80% of the wealth in Italy at the time was controlled by just 20% of the people. 20% of the families owned 80% of everything. That’s pretty astonishing.
And over time, other researchers, other scientists, whatever have discovered similar phenomena in just about all aspects of nature, and life. So for example, if you are a business owner, right, 80% of your profits will come from 20% of your products. Also, 80% of your sales will come from 20% of your customers. And on the flip side of that, 80% of your problems will also come from 20% of your customers, but usually not the thing 20% of customers are giving you revenue. If you have employees, 20% of your employees will be giving you 80% of your problems, right? And you know this to be true. So no matter what work you do, 80% of your results come from 20% of the tasks. Now, this is really counterintuitive, because we’re told since we were born, that you got to diversify, you know, don’t put all your eggs in one basket, you got to protect those eggs. Well, what if all the eggs are not worth protecting? What if there’s a better way? Right? So like I said, Koch has written about this book, many books on this topic, and he has tons and tons of examples. But the best examples are ones to look at your own life, and see for yourself how the ratio works for you. So 80% of your good times – 80% of the fun is going to happen with just 20% of your friends. 20% of the people, you know.
And in good times 20% People. Also, 80% of your fights are going to happen with 20% of the people you know, so good times, few people, bad times, different few people. So you make the call who you want to hang out with, right? It’s up to you, and on and on and on. There’s so many different examples in life that we can look at this. But then it gets even trickier if you go deeper. It’s not just 80-20 Okay? But it can be 90-10 it can be 95-5, it can be even 99-1, just like the 1%, who now control 99% of the wealth in the world, my goal is to be one of them. So I’m not knocking this, but it’s there. It’s something we cannot hide from. So it starts with 80-20. And then it gets more and more and more condensed. As time goes by. And it has been this way, for generations, it’s just an undeniable fact of life. Everything is not equal. And it never will be. I bet you didn’t know that the supply to the markets as well. So in the 20 years, from 1990 to 2010. Got 20 years of data there, the S&P 500 index, grew an average of about 8%. A little bit a little bit down, but average 8% a year. Not Bad, right? But if you take out the gains of just the top 10 stocks, which is 5% of the market, 5% of the index, you take those out, the index was actually negative, on average of 3.3% every year.
So you take out 10% of the top stocks, 10% of the stocks that did the best, and you’re losing money on the index. So yeah, I mean, you want to beat the stock market, just buy the top 10 stocks, she’s gonna need the whole index, and you can do much better than the whole index. Now, this is applied to other years. Yeah it does, according to FactSet. In 2021, the market was up a wami 28.7%. That’s a pretty good year, right? S&P 500 up 28%. Guess what? Just five stocks made up 31% of that game, just five, in 2020, the market was up 18.5%. And the top five stocks are just 1% of the index made up of 62% of that year’s gains. So 5 stocks, you got more than half of all the gains. 62% of all the games for that year was made up of just five stocks, no matter what you apply this to. Look, I mean, look for the instances that bring you the best results, and focus on those. So now how do we apply this to trading? I mean, you can apply this to all aspects of life. It’s like you’ve read the book over and over again, to see what I can do, I do with my kids, I do with my business I do with my health, I do with my personal life, I try to make it as much simple and streamlined and stressless as I can. And the things that are bothering me the things that are causing me stress, I get rid of the 20% that suck, you gotta get rid of it. Maybe this is where we’re the Jack Welch of GE got that from, you know, you take the bottom 20% of the people and you kick them out every year. I don’t know if I agree with that. If they’re doing their job, you let them stay. But yeah, they are not producing the results. But then in any employer, any business. 80% of the results come from 20% of the people. So maybe he should have been firing 80% of the people. I have a different ballgame. But how do we apply this to trading? Right? Let’s make some money on it. What do we do? Well, it’s like I say all the time, focus on what works. Focus on less, not more. I mean, it’s like Richard and I were kindred spirits. We both keep talking about the same thing. But very few people listen. Very few people listen. Oh, tha’s it. That’s it. Do you see it? It doen’t matter how many times I say it, right? Only 20% of the people that listen, or as you’re gonna hear me and implement.
That’s hilarious. It works in everything. It’s crazy. Okay, it’s gonna get back this. So let’s do this. All right, let’s do this. Go through your trade log. I hope you’ll give me one, right? All the trades that you’ve been doing for the past several years, go through it. And if you don’t have a trade log, and you don’t keep records of every single trade? Shame, shame, shame, you are missing out on a treasure trove of data that can make you better and that applies to you specifically, nobody else can give this to you. Nobody else can help you with this unless you have the data.
This is your own treasure trove. This is your own trading history. It’s not enough to go look at your statements. You got to record the stuff you got to record what was the trade? What was the strategy why you did the trade what was going on? I’ve been doing this for years and years and years. I mean, this binder right here. This is just one years of trades. This is just one year stuff that I have in here, different memberships and all that stuff, but I keep everything and I look at it. We go through it. That’s the only way to get better. Right?
And this is how you do it. When you go back to look at it. You will notice some things. 80% percent of your profits come from 20% of the strategies out there. So you need to focus on a strategy or handful of strategies that you do best and ignore the rest, stop jumping from shiny object to shiny object 80% of your losses will come from 20% of your trades. Okay, so you need to know how to limit the losses on those trades. Why did the loss happen? Find a way to fix it.
I keep hearing from people “Oh, yeah, you know, I do good for months at a time, a bunch of trades at a time. And then whooosh I give it all that. Yeah, that’s common, that’s normal. That’s the pattern, 80% of your losses come from 20% of your trades, but you got to know which trades, you got to know which strategy, you got to know why. Okay, 80% of your wins will be on 20% of the symbols. So you don’t need to trade every stock under the sun. Focus, specialize. Remember the principle, right? 80% of your losses will be the result of 20% of your mistakes, you’re going to make the same mistakes over and over and over until you fix them. And just a few just a handful of mistakes, you’re gonna make a lot of mistakes.
We all do. We’re traders, we make mistakes, you get in at the wrong time, you buy the wrong stock, you do this wrong time you get out, you don’t get out. We make lots of mistakes. Not all of them are deadly. Most of them don’t even make any difference. But there are 20% of the mistakes that lead to 80% of your results and your losses. Okay, every mistake is not equal. Get rid of the biggest of the worst ones. So to get better, you got to niche down, not out, niche down. You want to trade less, not more, okay? Want to trade less? Not more, less trades, not more trades, focused, specialized niche, and you always want to trade with the odds in your favor. With that, I bid you adieu.
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