Combining These 3 Things Can Make Investors Rich

The great thing about the stock market is that there is an endless supply of opportunities, but you have to constantly look for them and then wait for them to develop. Famed investor Jim Rogers once said, "I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime."

No matter how good of an investor you might be, you are not going to consistently make money in the market on a daily basis. In fact, you are likely to have many more losing days than winning days, but that is a good feature of the market and not a negative.

The reason that the market can be a source of incredible wealth is that returns are lumpy and inconsistent. Consistent returns are a product of low risk, and when you have little risk, then you are unlikely to have big returns. A money market account produces very consistent returns, but it is never going to produce giant returns because there is no risk.

The key to navigating the market is to embrace its lumpy performance and to use the cycles of ups and downs to find opportunities.

There are three related things that great traders use to deal with the erratic nature of markets: The first is the recognition of cycles, the second is the Pareto principle and the third is patience. These three things will determine how effectively you time your trades and find opportunities

The market is, and always will be, cyclical. It goes through ups and downs of various magnitudes on an irregular basis. The easiest way to deal with that fact is to embrace it. The 80/20 rule, or what is formally known as the Pareto principle, tends to apply to many aspects of the market. Most traders and investors make 80% of their profits during 20% of the time they are at work. The other 80% of the time, they make very little progress or lose money.

The Pareto principle states that approximately 80% of the effect of something comes from 20% of the causes. 20% of the time, your efforts will produce the desired results, while 80% of the time, you are spinning your wheels and not making any money.

For example, in business, 80% of revenue often comes from 20% of customers. In economics, it has been observed that 80% of the wealth in the world is controlled by 20% of the people. There are numerous other examples of this rule in economics, business and science.

The problem is that we never know when that period of peak profitability will occur. We must be constantly vigilant and ready to spring into action when favorable conditions occur. When they do occur, we have to ramp up our aggressiveness and profit while we can.

The Pareto principle goes hand-in-hand with the cyclical nature of the market. Not only are there cycles of bull and bear markets, but just about every other aspect of the market goes through a series of ups and downs. Sectors rotate, the economic cycle occurs, interest rates rise and fall and thousands of other factors are shifting. We have to be very patient while these cycles develop and expand, but the one constant is that they will offer opportunities.

A trait effective traders share is the ability to be patient and do little for long periods of time, and then move suddenly and decisively when the time is right. Shifting from a patient state of mind to a more active one is a behavior that needs to be cultivated. We need to know when the time is right to walk over and pick up that money sitting in the corner.

One of the biggest mistakes that traders try to make is to force trades and to act prematurely. The inclination is always to take action, although 80% of the time, that action is not going to be very productive.

Hard work will be rewarded, but it won't be rewarded on a daily, weekly or monthly basis. It will be sporadic and unpredictable. Once you realize you are powerless to control when your efforts pay off, then you can avoid some of the frustration that occurs when things are tough.

This past week, there was a major rotation into small-cap stocks. Many traders have been waiting for small-cap action for years, and many of them depleted capital as they tried to force trades before the cycle had actually turned.

The tricky part is that you can't pick and choose when you are going to have that 20% of the time when things are going very well and you are racking up big gains. You have to keep working at it and be ready for those times when things come together.

When conditions have shifted and stocks are acting well, then the likelihood is that you are in the 20% payoff period of the Pareto principle, and it is time to press. When things aren't working, and you are treading water, then recognize it and focus on keeping losses small and wait for conditions to change.

Rogers recognized that market cycles will always turn, and if an investor employs patience and the Pareto principle, then producing good gains is inevitable.

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At the time of publication, DePorre had no position in any security mentioned.