Filter Rule: What It Is and How It’s Used

What Is a Filter Rule?

A filter rule is a trading strategy that sets parameters for when to buy and sell investments. The filter rule is commonly based on the belief that rising prices tend to continue to rise, and falling prices will continue to fall.

When using a filter rule, investors commonly mark a percentage change from prior prices. The designated percentage change may trigger a buy or sell depending on the movement of the price up or down. It is a subjective strategy, as the percentage level selected is based on the trader's analysis.

Key Takeaways

  • A filter rule is a trading strategy based on price movements, with trades typically dependent on a percentage change in price.
  • The trader may use technical analysis or charts when determining which percentage works best for their investment.
  • Filter rules are based on historical trends and security price patterns identified from an asset's price chart.

Understanding Filter Rules

Technical analysts use their discretion when setting parameters for filter rule trading. Generally, filter rules are based on historical trends and security price patterns identified from the price chart of an asset.

A technical trader may notice that when the price rises 5% above a chosen level, it tends to move another 10% in that same direction. Therefore, the trader may use a filter rule to look for stocks that move 5% off a prior closing price, low, or high.

The percentage is commonly based on short-term trends with securities moving between 1% and 10%. The levels could be smaller, such as 0.2% or 0.5% if based on intraday price movements. When using a filter rule, the trader must decide to trade in both directions, up and down, or only in one direction.

1% Buy/Sell Filter Rule

Under a 1% buy/sell filter rule, a trader buys a stock when its price rises 1% above a previous close price, low price, or high price. The trader then sells it when its price falls 1% below a previous close, low, or high.

Technical Analysis and Parameters

Implementing filter rules requires software that provides technical analysis or charts that can be set for price alerts or to execute trades automatically based on an investor’s preference. Some traders elect automated trading, which allows them to take advantage of trading opportunities more rapidly.

Depending on the parameters, a filter rule can result in a large or small number of trades. Small parameters, such as 1%, will trigger far more transactions than 15% or 20%. Frequent traders must pay attention to commissions and position size. Commissions should be low enough and position size large enough to cover the costs of frequent trading on small price moves.

Trading Example

Assume a day trader is interested in applying a 0.6% filter rule on Apple (AAPL).

If the price moves 0.6% off a recent swing high or low, the trader enters. They will exit their position if the price moves 0.6% in the opposite direction from a swing high or low. The investor applies this strategy between 9:30 AM and noon EST only, and any open position is exited at noon.

The chart shows how this could have played out on a day when the stock moved over 3% during the allowed period.


Image by Sabrina Jiang © Investopedia 2021

The first trade resulted in a 2.29% gain. The second trade results in a 0.14% profit. The third trade results in a 0.03% profit. This assumes no slippage on orders, and commissions must also be factored in.

The strategy discussed is for demonstration purposes only and is not a recommendation or advice.

What Is the Difference Between a Trade Filter and a Trade Trigger?

A trade trigger is commonly a rise or fall in the price of an index or security, which triggers a sequence of trades. Trade triggers are used to automate certain types of trades, such as the selling of shares when the price reaches a certain level. A trade filter is a criterion used to narrow down, or screen, investment options.

What Are Technical Analysis Indicators?

Common technical indicators that help find attractive stocks include:

  • Support and resistance: A stock is reliably moving between a consistent low and a consistent high.
  • Trend lines: Connecting a simple line on a price chart shows if a stock is trending in a bullish or bearish direction.
  • Moving averages: A moving average is the sum of the prices over a period divided by the time period.
  • Volume: Large volume trading indicates high market interest, while lower volume may indicate less trader interest.

What Are Common Filtering Techniques?

A common filter is to hone in on stocks with prices above their moving averages. Traders also filter for stocks that have broken through support or resistance and have an increasing market interest.

The Bottom Line

A filter rule is a trading strategy based on price movements, typically dependent on a percentage change. Technical analysis or charts help investors determine the best filter rules to apply when trading stocks.

Article Sources
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  1. Charles Schwab. "Filtering the Market Using Technical Analysis."

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