DEFINITION of 'Filter Rule'

A trading strategy where technical analysts set rules for when to buy and sell investments, based on percentage changes in price from previous lows and highs. The filter rule is based on a certainty in price momentum, or the belief that rising prices tend to continue to rise and falling prices tend to continue to fall. It is often considered a subjective screener, due to it being set by an analyst's own interpretation of a stock's historical price history.

BREAKING DOWN 'Filter Rule'

For example, under a 1% filter rule, an investor would buy a stock when its price rose to 1% above a previous low and sell it when its price fell to 1% below a previous high. Two research studies of filter rules from 0.5 to 20% found that only the 0.5% filter rule could generate above-average returns, but because of the high transactions costs associated with the frequent trading necessitated by the rule, the investor would not actually come out ahead.

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