Bernie Madoff and the 80/20 Rule
Everyone is familiar with the 80/20 rule. Everyone accepts its validity in almost all aspects of life. 20% of your customers drive 80% of your profits. 20% of all workers are responsible for 80% of all output so on and so on and so on.
The 80/20 rule isn’t some sort of a scientific certainty but rather a generally good representation of real life. Even when it comes to our own work ethic if we were truly honest with ourselves we would concede that 80% of all our productivity is usually produced in only 20% of the time. The rest of the day we tend to goof off.
Yet when it comes to trading none of us wants to adhere to the 80/20 rule. No one wants to make 80% of the money in only 20% of the time. Scratch any trader deep enough and they’ll admit that what they really want is to make money 80% of the time. But that’s not only unrealistic but actually very destructive.
After all why was Bernie Madoff’s con so successful? Because he tapped directly into that need for consistency. He didn’t promise outsized returns he simply manufactured steady 1% gains on a monthly basis and his customers were thrilled. When real traders looked at those returns they knew immediately that something was wrong. Such low volatility results are simply impossible to achieve in any financial market and especially one as difficult as options.
The topic of 80/20 came up a lot in conversations with my colleagues at this weeks Forex trading expo in Las Vegas. We all trade very different styles but all of us agreed that if were to carefully examine our trading records the 80/20 rule applied almost universally. In fact the single BEST thing that a trading strategy can do is just tread water during the 80% of the time that it is not performing.
That’s hardly a sexy sell but it is an absolutely fundamental fact of successful trading. So next time your trading account spends months just churning around the same net asset value, don’t despair. You are actually doing something right.