A filter rule is a trading strategy in which 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 generally on 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.
A filter rule can be a good way to profit from changes in a security’s price. Technical analysis software programs will have certain features that allow analysts to implement filter rules.
Technical analysts use their investing discretion when setting parameters for filter rule trading. Generally filter rules will be based on historical trends and security price patterns identified from technical analysis charts. Filter rules can include orders to buy or sell based on price increases or decreases. Typically trading percentage will be based on shorter-term trends which often result in price filter triggers for securities moving between 1% and 10%.
Traders can set all kinds of filter rule trading orders. Some traders may choose to filter a trade when a stock rises or falls by a certain percentage. Some traders may vary the percentage change increase and decrease required for a trade. Additionally, some traders may only filter trading orders for certain increases or specific decreases.
For an example, under a 1% buy/sell 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. If this investor only wanted to focus on a bullish trend they could set a filter rule that would only buy with a 1% increase in the price.
Research studies of filter rules from 0.5% to 20% have found that lower percentage filters are more successful than higher percentages. This is especially true in situations where high trading costs are also associated with a trade.
Implementing filter rules requires software which provides for this feature. Generally technical analysis trading software systems can be set to provide alerts or execute trades automatically based on an investor’s preference. Some traders may elect for automatic investing which allows them to take advantage of trading opportunities more rapidly. In other situations, traders may wish to be alerted of price changes in order to make their own investing decisions.