Trying to time the stock market is always problematic, as investors need to know when to get in and when to get out. The eight-week hold rule is a stock investment strategy that attempts to pinpoint the best time to sell the winners in a portfolio to maximize profits.
“The basic rule is that if a stock breaks out of a base (i.e. a narrow range) where it’s been trading for a while and gains 20% in three weeks or less, you should hold for at least eight weeks,” says Ian Rayner, founder of Rayner Gobran.
The week in which a breakout occurs is when the clock starts ticking on the eight-week hold rule. The key tenet of the rule is to sit tight on a stock even when others are selling to capitalize on upward pricing momentum.
It’s about seeing how pricing trends play out, says Kayse Kress, a certified financial planner at Physician Wealth Services. “If the market continues to favor your stock, you can continue to gain in value.”
Here are three things you need to know about the eight-week stock investment strategy:
— It doesn’t work for every investment.
— There are no clear guidelines on when to sell.
— Emotions can get in the way.
It Doesn’t Work For Every Investment
The biggest obstacle with any investment strategy is that short of owning a crystal ball, it’s impossible to gauge exactly what the stock market will or won’t do next. The eight-week rule may be effective for managing volatility with certain types of stocks, but not others.
Roberto Castaneda, director of the accounting program at Walden University, says investors should apply the rule only to publicly traded stocks that are proven market leaders with strong fundamentals and quality institutional sponsorship. Stocks with poor annual earnings growth or a spotty pricing history may not fit the mold.
It’s also important to pay attention to the overall attitude of the stock market before utilizing this approach.
“Investors should avoid blindly using the eight-week rule without giving regard to which way the market is headed or bad news coming out on the company during the hold period,” Castaneda says, since both can quickly turn stock gains into losses.
That makes the rule better suited to bull markets, rather than bearish ones. Finding the right investment vehicles can be particularly problematic if prices are on a downward trend. “Since most stocks are highly correlated to the market as a whole, there are going to be very few breaking out and gaining 20% in down markets,” Rayner says.
The silver lining is being able to strategically manage risk against rewards.
“Investing in a single stock may take on too much risk by the investor and not necessarily match the risk with the return,” Castaneda says.
The rule can help minimize risk by utilizing a regimented approach to individual stock trades.
There Are No Clear Guidelines on When to Sell
The eight-week rule gives investors direction on how long to hold but it’s not definitive on exactly when to sell once that milestone is reached. This is where the issue of trying to time the market can present a challenge.
“The problem with this approach is that as your stock value fluctuates in price over the eight weeks and beyond, when to sell out becomes anyone’s guess,” Kress says.
Kress hits on a familiar point: that no one can accurately predict exactly how individual stocks will perform from day to day. “Putting your long-term investments into stocks for eight weeks at a time can cause adverse tax effects and other negative implications to your investment portfolio.”
Rayner says it’s more appropriate to look at the rule as a trading strategy, rather than an investment strategy. “Academic studies show over and over that investors should not attempt to time the market,” he says.
Committing to a longer term, buy-and-hold strategy that focuses on broad market indexes may be the better approach to take. Rayner says making the eight-week hold rule work efficiently may require a laser focus on stock market movements from day to day, something that may not be realistic for every trader.
A more traditional buy-and-hold outlook may work better for the passive investor who isn’t as hands-on. With this type of investment strategy, the goal is to encourage portfolio growth over the long term regardless of how the market fluctuates up or down over time.
Emotions Can Get in the Way
Investing and emotions often make for a poor combination in a portfolio. Certain biases can develop that cloud an investor’s decision-making.
Recency bias, for instance, assumes that what has happened recently will continue to happen. That kind of thinking could lead to an incorrect assumption about when the best time is to sell following the eight-week rule. But stock gains may not follow the rule to a tee, Castaneda says, so investors should be cautious.
The eight-week rule attempts to set parameters and guidelines to avoid emotional selling. The problem, Kress says, is that those guidelines or parameters by themselves don’t hold much value.
In other words, watching for a breakout point and a 20% or more gain by itself isn’t a foolproof stock investment strategy.
“The absolute best rule of trading is sell your losers and let your winners run,” Rayner says. “The eight-week rule is the exact opposite of the second part of that advice and is mute on the first.”
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How the 8-Week Rule Affects Your Stock Investment Strategy originally appeared on usnews.com