What is a Filter Rule?

In finance and investing, a filter rule is a strategy that is employed to assist investors to arrange the buying and selling of holdings so that the highest amount of profit is realized from the transactions. In most cases, the creation of this type of rule will focus on the evaluation of past trends regarding the unit price of each share of stock. While some investors find this basic method helpful, detractors believe that the concept of filter rules is of little to no value in making investment decisions.

While there are some variances in the way a financial filter rule may be crafted, the rule normally involves looking at the changes in price for the investment over a specific period of time. The idea is to use the changes in price to identify some sort of ongoing pattern, making it possible to determine when would be the best time to buy or sell the investment. In actual use, the investor creates a point of action in which the holding will be bought or sold, usually when the unit price reaches a specific percentage above or below the original purchase price used in the evaluation.

For example, the filter rule guide may be to take action when the unit price rises or falls by ten percent. For filter rule buying, this means the investor will move in to purchase units or shares as soon as the stock or commodity begins an upward climb that exceeds ten percent of the price that was set as the standard. At the same time, filter rule selling will take place when a holding already in the portfolio drops by more than ten percent below the unit price paid to acquire the shares.

In theory, setting a rule of this type would prevent an investor from losing a great deal of money on any holding that begins a downward slump. At the same time, the rule would alert the investor to an opportunity that is showing promise to increase substantially in the short term, since it has already begun an upward climb. Applying the rule to all holdings would then create a balance in the investment portfolio, keeping it more or less stable and less subject to devaluation due to moving too slowly with either type of transaction.

Detractors point out that in actual practice, a filter rule does not always attain these goals. In fact, there are other indicators that would alert the investor to sell well before a holding has decreased in value by some fixed percentage. Relying on those several indicators instead of a rule based on the one indicator of past performance in terms of price will likely result in less of a loss incurred, and possibly eliminate the realization of a loss altogether.

In like manner, considering a wider range of indicators than are usually associated with the creation of a filter rule will often allow the investor to purchase shares before they begin to increase in value. This makes it possible to earn more of a return than would have been possible if the investor had waited until the investment reached some specific level of increase. Because of the limited scope of the rule, many brokers and other financial experts consider it to be one of the less reliable ways to manage investments.