What Is The 80% Rule?

The 80% rule is a powerful concept in day trading that revolves around value area—an area where the majority (typically 70%) of the previous day’s trading activity occurred. 

This rule provides a strategy for predicting and capitalizing on potential market movements based on the initial behavior of the price relative to the value area. It’s a favored technique among day traders for its simplicity and effectiveness in identifying high-probability trading opportunities.

Understanding the 80% Rule

Here’s a breakdown of how the 80% rule works in the context of value area trading:

1. Identification of the Value Area: The first step involves identifying the value area from the previous trading session. This is the range where 70% of the previous day’s trades were executed, indicating a zone of significant trading activity and interest.

2. Initial Market Movement: The rule comes into play when, in the current session, the price initially moves outside of the previous session’s value area but then re-enters it. This re-entry is a critical trigger that suggests the market may lack the momentum to sustain its movement outside the value area, hinting at a potential reversal or significant move within it.

3. The 80% Probability: Once the price re-enters the value area, the 80% rule posits that there is approximately an 80% chance that the price will continue to move through the value area and reach the opposite side. This is based on historical observations that show a strong tendency for the market to explore the full extent of the value area once it re-enters after initially breaking out.

4. Application in Trading: Traders use this rule to set up trades that capitalize on this predicted movement. For example, if the price moves back into the value area from above, a trader might take a short position, anticipating the price to traverse the value area towards the lower end. Conversely, if the price enters from below, the trader might go long, expecting the price to move towards the higher end of the value area.

How to Use the 80% Rule for Day Trading

• Entry Point: The entry point for a trade based on the 80% rule is triggered when the price re-enters the value area after initially moving outside of it. This is seen as a signal that the price is likely to traverse the value area.

• Stop Loss: To manage risk, a stop loss is often placed just outside the value area from which the price re-entered. This limits potential losses if the price reverses direction again and moves out of the value area, invalidating the 80% rule prediction.

• Profit Targets: The primary profit target is typically set near the opposite end of the value area, capitalizing on the expected movement across it. Traders might also look for secondary signals or use partial profit taking as the price moves in their favor.

Importance of Context

While the 80% rule offers a high probability setup, it’s crucial for traders to consider the broader market context before executing trades. Factors such as market sentiment, news events, and overall market trends can influence the effectiveness of the rule. Successful application often involves combining this rule with other technical analysis tools and indicators to confirm signals and manage risk effectively.

Conclusion

The 80% rule in value area trading is a testament to the importance of understanding market psychology and price action. By leveraging the predictable behaviors of traders within the value area, day traders can find high-probability trading opportunities that align with market dynamics. Like all trading strategies, success with the 80% rule requires practice, discipline, and a well-rounded approach to risk management.