Does 80/20 rule apply to trading?

[Kim 7,943]

I assume most of you are familiar with the 80/20 rule. As a reminder, the rule states that, for many events, roughly 80% of the effects come from 20% of the causes. Few examples:

• 80% of your profits come from 20% of your customers
• 20% of the people owned 80% of the wealth.
• 80% of your complaints come from 20% of your customers
• 80% of your profits come from 20% of the time you spend
• 80% of your sales come from 20% of your products
• 80% of your sales are made by 20% of your sales staff
• In software, by fixing the top 20% of the most reported bugs, 80% of the errors and crashes would be eliminated.

So how does it apply to trading?
 

If you go to your trading log, you probably will find out that 80% of your profits came from 20% of your trades. In the 1993-2010 period, the 10 best days (4% of all trading days) account for 50% of the buy and hold performance. I'm sure that 40 best days (20% of all trading days) will account for at least 80% of the gains, maybe more. Look at SteadyOptions performance page - a big chunk of our gains this year came from May, July and August performance.

How does it help us?

What many novice traders don't realize is that the best trading strategies are usually boring. You can wait months for that one nice winning streak, and then in couple of weeks or even days you make a year worth of profits. The trick is to survive during those "boring" periods which are 80% of the time. If you manage to be around breakeven (give or take few percent) per month during those periods, you will be glad that you were patiently waiting for that one winning streak.

Going back to SO performance, I think our biggest achievement was avoiding big losses. Sure we made some mistakes (mainly holding few trades through earnings), but overall, our drawdowns have been minimal so far. Patiently waiting for the next winning streak proved to be very rewarding.

To conclude, I wanted to share few interesting posts discussing the 80/20 rule and how to apply it to trading:

• http://www.thecrossh...-stock-trading/
• http://www.tigershar...ding/Page1.html
• http://www.mrswing.c...rading_916.html

Would love to hear your thoughts.

[ammarmalhas 5]

First time I hear of this rule, but I really agree with it. Damn it is so right. Maybe I had a feeling this was the case when I decided to make a yearly subscription at SO

:D

Edited December 21, 2012 by ammarmalhas

[Xfanman 9]

This (as I'm sure Kim knows) is called the Pareto Principle named after an Italian Economist. You can read more about it here if you're so inclined -->

http://en.wikipedia.org/wiki/Pareto_principle

I agree with Kim that it applies to many aspects of life, business and investing!

[ammarmalhas 5]

Very interesting. it seems to me that everything around us and all we are, are mathematical formulas of a higher order. A fifth of something cause 4/5th of the effects. The 5th (%20) number is part of the Devine Proportion! Hmmmm!

[Bullfighter 385]

 I have put all the SO Trades from the Performance page into a spreadsheet and calculated the following:

About half the money made by the model SO trades comes from calendars, and about 80% are a combination of calendars, strangles and straddles.

 

Things are more distributed by tickers, but you can see GOOGL is a favorite money maker

 

Now, how much is it because some strategies are traded more often and when because that strategy is more profitable? Since all trades are sized in proportion to a 10K portfolio, I thought that to truly compare apples to apples we have to look at dollar returns:

 Calendars are not only traded the most often, but they have a pretty decent average return based on the standard allocation. Straddles are the most traded strategy, it lasts 5 days on average, but the average return is $29. Hedged straddles improve returns at the expense of almost twice the days in trade. More visually:

These calendars are truly great!

[Kim 7,943]

Thanks for putting this together @Bullfighter

Your conclusions are in line with statistics put together by @Yowster every year - 2020 Year End Performance by Trade Type.

It is true that calendars are historically our best performers, but they are also higher risk than straddles. We prefer to trade both to hedge and balance our portfolio.

[Bullfighter 385]

Yes, it's not only the returns, but the volatility of your equity curve that matters, or how much you suffer along the way. I decided to put together some equity curves, assuming that on day 1 we have $10000 and then I execute only calendars, and repeated that with strangles, straddles, hedged Straddles, RICs, calendars and straddles together, and the whole set of SO trades.

The first thing you will notice is that calendars on their own are great, probably because they tend to start half size.

 

Strangles started strong but have been just doing nothing

 

 

Straddles are slow and steady, rarely producing big drawdowns.

 

Hedged straddles joined the party rather late, so it may be too soon to say if the current chop if the curve will remain so

 

RICs really had to go

 

Once you start combining, the curve starts smoothing. This is just calendars and straddles:

 

The combination of great, good, and not so good strategies, having their successes and failures along the way, really smoothed the equity curve of SO:

 

This shows why SO has such a high Sharpe ratio.

I am glad I discovered SO! Excited to learn all these strategies!

 

Edited September 11, 2021 by Bullfighter
Cleaned up the images mess

[kg200004 2]

Thank you @Bullfighter for the comprehensive data analysis. By the way, the equity curve images you posted aren't visible for some reason. 

[ykotowitz 20]

28 minutes ago, kg200004 said:

Thank you @Bullfighter for the comprehensive data analysis. By the way, the equity curve images you posted aren't visible for some reason. 

same here.

[Bullfighter 385]

2 hours ago, kg200004 said:

Thank you @Bullfighter for the comprehensive data analysis. By the way, the equity curve images you posted aren't visible for some reason. 

 

1 hour ago, ykotowitz said:

2 hours ago, kg200004 said:

Thank you @Bullfighter for the comprehensive data analysis. By the way, the equity curve images you posted aren't visible for some reason. 

same here.

Sorry, I guess I did something wrong. It should be fixed now!

[canary 5]

Fixed!!. At least I can see them. Congrats for the work.