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How to use Pareto principle to gain edge in stock trading?

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Publish Date: December 06th, 2019

By: Sandhya Kannan, Head – Content

Certain principles once explained make so much sense that they seem to have always been a part of your subconscious. The Pareto principle is one such principle.

Who discovered the Pareto principle?

Vilfredo Federico Damaso Pareto is the man who discovered this principle. He noticed that it is 20% of the things done or efforts made that generate 80% of our results. The way to visualise this concept is to look at your investment portfolio. It is 20% of the stocks that give 80% of the returns. This principle is universal and you can notice it in many basic activities of life.

For example, the percentage of apps that you have versus the ones you use regularly, the number of clothes you have versus the ones you wear regularly, 20% of the salespeople in most companies generate 80% of the sales. The list of examples will astound you.

How to apply the Pareto principle?

People who are high achievers use the Pareto principle to identify what is 20% of their work or task ahead that is responsible for 80% of the success. They go ahead and identify that crucial 20% and ensure that it is done to their best – no compromises or failings are acceptable. The remaining 80% can be delegated, it can even be done away with if not crucial to the task. By using the Pareto principle they effectively manage to utilise their talents and abilities in the best way possible.

Now let's apply this fantastic Pareto principle to the world of share market and stock trading. Take the time and study it. You can start with scrutinising your own current portfolio and then moving on to stocks that are doing well in the share market. On closer appraisal and with the Pareto principle in mind, you will see that the share market is quite willing to give up its secrets and it is quite clear which are the top 20% of the stocks listed. They need not all be the blue chip stocks, but you will see which stocks show promise and have been generating the maximum returns. The trick is to stay invested in these stocks and cultivate the ability to withstand small movements in the market

The Pareto principle can also be applied to stock trading. You will notice you have trades that can be divided into the ones that create good profit, ones that create losses, and ones that remain net-to-net. Concentrate on the ones that have the ability to pay high returns. Don't hang on to the ones that don't adhere to this principle and stay invested in the ones that have stayed true to the Pareto principle.

Remember – 80% of the result will come with 20% of smart analysis and action. You don't need to run after small things that will distract you from the crucial 20%. Share market and stock trading will be your new playground. Apply the Pareto principle and bring the winnings home.