How the 8 Week Rule Affects Your Equity Investment Strategy | Portfolio Management
Trying to time the stock market is always problematic, as investors need to know when to enter and when to exit. The Eight Week Hold Rule is an equity investment strategy that attempts to determine the best time to sell the winners of a portfolio in order to maximize profits.
“The rule of thumb is that if a stock comes out of a base (i.e. a narrow range) where it has been trading for a while and is gaining 20% in three weeks or less, you should hold it for. at least eight weeks, ”says Ian Rayner. , founder of Rayner Gobran.
The week in which a breakout occurs is when the clock begins to run by the eight week hold rule. The key principle of the rule is to stay focused on a stock even when others are selling to capitalize on rising price dynamics.
It’s about seeing how pricing trends evolve, says Kayse Kress, Certified Financial Planner at Physician Wealth Services. “If the market continues to favor your stock, you can continue to rise in value.”
Here are three things you need to know about the eight week equity investing strategy:
- It does not work for all investments.
- There are no clear guidelines on when to sell.
- Emotions can bother you.
It doesn’t work for every investment
The biggest obstacle to any investment strategy is that unless you have a crystal ball, it is impossible to gauge exactly what the stock market will or will not do next. The eight week rule can be effective in dealing with volatility with some types of stocks, but not with others.
Roberto Castaneda, director of the accounting program at Walden University, says investors should only apply the rule to publicly traded stocks that are proven market leaders with strong fundamentals and quality institutional sponsorship. Stocks with low annual profit growth or an uneven price history may not fit the mold.
It is also important to pay attention to the overall attitude of the stock market before using this approach.
“Investors should avoid blindly using the eight week rule regardless of the direction the market is going or bad news about the company during the holding period,” Castaneda said, as both can quickly turn gains stock market losses.
This makes the rule better suited for bull markets rather than bear markets. Finding the right investment vehicles can be particularly problematic if prices are trending down. “Since most stocks are highly correlated to the market as a whole, there will be very few that come out and gain 20% in bear markets,” Rayner said.
The silver lining is being able to strategically manage risk versus rewards.
“Investing in a single stock may take too much risk for the investor and may not necessarily match risk with return,” Castaneda says.
The rule can help minimize risk by using a regulated approach to individual stock transactions.
There are no clear guidelines on when to sell
The eight week rule gives investors guidance on how long to hold it, but it’s not definitive exactly when to sell once that milestone is reached. This is where the question of trying to time the market can present a challenge.
“The problem with this approach is that, as the value of your stock fluctuates in price over the eight weeks and beyond, it becomes a puzzle to sell when to sell,” Kress explains.
Kress hits on a familiar point: No one can accurately predict the performance of individual stocks on a day-to-day basis. “Placing your long-term investments in stocks for eight weeks at a time can have negative tax effects and other negative implications for your investment portfolio.”
Rayner says it’s more appropriate to think of the rule as a trading strategy rather than an investment strategy. “Academic studies repeatedly show that investors shouldn’t try to time the market,” he says.
Engaging in a longer term buy and hold strategy that focuses on broad stock indices may be the best approach to take. Rayner says that for the eight week hold rule to work effectively, it may be necessary to laser focus on day-to-day stock market movements, which may not be realistic for all traders.
A more traditional buy and hold perspective may work better for the passive investor who is not as convenient. With this type of investment strategy, the objective is to encourage the growth of the portfolio over the long term, regardless of the upward or downward movement of the market over time.
Emotions can get in the way
Investment and emotions often make a bad combination in a portfolio. Certain biases can develop and cloud the decision-making of an investor.
Recency bias, for example, assumes that what happened recently will continue to happen. This kind of thinking could lead to an incorrect assumption about the best time to sell by following the eight week rule. But stock market gains may not follow the rule to the letter, Castaneda says, so investors need to be careful.
The Eight Week Rule attempts to set parameters and guidelines to avoid emotional selling. The problem, Kress says, is that these directives or settings on their own don’t have much value.
In other words, watching a break point and a gain of 20% or more on its own is not a foolproof equity investment strategy.
“The best absolute rule in trading is to sell your losers and let your winners run,” says Rayner. “The eight week rule is the exact opposite of part two of this advice and is silent on part one.”