Thursday, 27 January 2011

Cassini Principle

I am currently reading "Stumbling On Wins", by David J Berri and Martin B Schmidt, a Xmas gift from my daughter, and came across a reference to the Pareto Principle, also known as the 80-20 rule, the law of the vital few, and the principle of factor sparsity, (which sounds more like a medical condition) which states that, for many events, roughly 80% of the effects come from 20% of the causes. The original observation was in connection with income and wealth. Italian economist Vilfredo Pareto noticed that 80% of Italy's land was owned by 20% of the population. He then carried out surveys on a variety of other countries and found to his surprise that a similar distribution applied. (He also observed that 20% of the pea pods in his garden contained 80% of the peas - some people really should get out more).

Anyway, my initial thought on reading this was the possibility that a similar ratio applied to my returns from trading, i.e do 80% of my profits come from 20% of the time that I spend trading. Now that my daily trading records go back a full five years, over 1,850 days, (Vilfredo isn't the only one who should get out more), this should be fairly easy to measure.

The 80-20 rule doesn't handle negatives too well, and unfortunately my daily totals do occasionally include a red number. Nevertheless, I ran the numbers and found that just my best 112 days comprised 80% of my profits from five years of trading. If only I knew in advance when those 112 days would be!

It's certainly a fact that my profits are not evenly distributed across all months as I have noted before, and taking a complete break during the six months of April through September would have the effect of reducing my profits by just 22%. I make 78% between October and March. Not quite the 80-20 rule, but I'm proposing a new rule for traders which proposes that 80% of profits are made in half of the year. It's called the Cassini Principle. Cassini / Pareto - we're both of Italian heritage, we both like our numbers, and we both have principles, but the similarity ends there. I shall not be counting peas in my garden. OK, so we should both get out more, and I may well do that in April, which has a record of three losing months (out of five) and an overall loss. Trouble is, the competitive nature in me means I'm more determined than ever to turn April around this year.

Any traders out there who can run their numbers and see if the Cassini Principle holds true?

1 comment:

Steve said...

As always an excellent post, trading is boring, but you sure know how to brighten it up