How to Follow the Pareto Investor

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The Pareto Investor - 80/20 Rule to Investing
How to Follow the Pareto Investor

We’re going to skip the news that rattled the markets this week.

Instead, we’ll continue to understand the Pareto investor. After all, I did promise you that part two was coming this week.

If you missed part one for whatever reason, you can read it here. Then jump back to this article and continue reading.

You may not know this, but I’ve rubbed shoulders with some of the brightest Aussie investors.

They all had one thing in common.

The new breed of investors

As a reminder, the Pareto principle, also known as the 80/20 effect, was named after Vilfredo Pareto.

Pareto was an Italian economist-sociologist who worked at the University of Lausanne in Switzerland.

This principle changed the way we prioritise what we do.

If you apply this strategy to your trading portfolio, you will make smarter, more rational decisions.

Let me explain what I mean…

Traders and investors who attempt to day trade typically lose.

But would it be a stretch to suggest that a whopping 80% of these traders and investors lose?

Well, if you were to apply the 80/20 rule…it would make perfect sense.

But I cannot invest based on sense alone; I need some proof. So I decided to investigate this and here’s what I’ve found…

Yes, 80% of traders lose

In 2016, a researcher by the name of Alex conducted a private study on this topic.

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Alex considers himself a data and visualisation nerd. So, while I won’t consider this a scientific study, I found what the study suggested to be quite interesting.

(It’s worth pointing out that day trading is only loosely defined in this study. Day trading may last a single day, but can stretch to a week.)

Back in 2016, Alex collected all the publicly available data from a social trading feature on eToro.

You may know of eToro. It’s a social trading platform and a broker. It recently launched right here in Australia.

At the time, eToro’s social trading feature was open and all performance history was available publicly.

And Alex, being a data-savvy nerd, thought it would be a good experiment to test the day trader theory.

Here’s what he found…

Of the 83,300 traders who made at least three trades over a 12-month period, an astonishing 79.5% lost money. And no, this wasn’t paper money — it was based on real trades.

That number is pretty damn close to 80%. I’d say this theory works as intended here.

Now here’s the crazy part: The median 12-month return was a silly
-36.3%.

Here’s the data…

Source: CuriousGnu

Now, let me sum this up for you…

I’m sure we can agree that the 80/20 effect is real.

So, how do you apply this to your investing methodology?

Do this to increase your odds

You should spend 20% of your time on the tasks that yield 80% of the results.

This is clearly easier said than done.

But one of the ways you can do this is to adopt a preferred investment style.

What worked for me was technical analysis. But it wasn’t always that way.

It took a few years to become my preferred method.

Though, rubbing shoulders with great Aussie investors did teach me something: Don’t be good at many things. Instead, be great at something.

Today, I use this rule to guide my investment decisions. I focus only on five technical tools.

I call these my primary indicators.

And rarely, if ever, do I make my investment decision based on a company report.

That’s because I believe I can learn everything about the company from the chart.

After all, if I can focus on just that 20%, then I shouldn’t be too concerned about the remaining 80%.

I’d suggest you look to do the same. Is there something you’d say you’re great at?

If there is, make it your primary indictor. It could be anything, such as buying companies when they report positive earnings.

Or perhaps when two moving averages cross over.

Find an edge in the market, then stick to it. Your consistency should pay off over time.

Until next time,

Jonathan Evans Signature

Jonathan Evans,
Analyst, Profit Watch

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