After the recent release of Phil Town’s book, Rule #1 (review), many people seem to be asking about “the arrows.” What are these mysterious arrows anyway? And can you make money just by using them?

Arrows are simply a visual way to show a chart reader that a key statistic has generated a buy or a sell signal. Buy signals are usually green arrows pointing up and sell signals are usually red arrows pointing down. Have a look at a sample chart from INVESTools.

In this image you can see arrows being displayed from 3 different statistics: 30-day Moving Average, MACD, and Stochastics. I won’t bore you here with what these statistics mean, but if you look closely you’ll see that there are arrows whenever a key threshold or “trigger” has been reached. Here are the triggers for each of the statistics on this chart:

INFY 6-Month Chart

Moving Averages (MA): the price line crosses above or below the MA line.
MACD: the histogram reaches 0, either heading up or down.
Stochastics: the line crosses above the 25th or below the 75th percentile.

As you can see, you can pull all the information right off the chart if you wanted to, but the arrows just make it really easy to read. Most professionals who use charts like this look at tens if not hundreds of charts a day, so these little indicators can really save time. It’s also important to remember that each software package can use slightly different triggers and statistic configurations, and you should read up on how they work before you settle down with one tool.

So can you make money just by using them? Let me answer this last question quickly: NO!!!! (added ‘!’ for emphasis). If you guessed that might be the answer, you were right. For the beginning investor, I believe you should learn how to buy good companies at good prices. This is the basis of fundamental investing, and I believe provides a good foundation to get into other more aggressive styles. Basic idea: Look for companies that are growing and their prices should* eventually go up.

Arrows are used in what is known as technical analysis, which is used to help determine when to buy as stock. This is a perfectly valid study, but a lot more is involved than simply reading the arrows. You also want good price movement, or growing buzz on the street. Using arrows is valuable, but don’t be alarmed if 3 green arrows don’t propel your stock 500%. Strong buy signals get flagged all the time, even for garbage stocks. Use it as one of your factors, but not as the factor.

Unfortunately, my major criticism of Phil Town’s book is that his technical game is very weak. Using the arrows doesn’t totally remove the chance that you could lose money. If you follow the arrows, it is possible to lose a small percentage of your investment. For example, I followed Phil Town’s methods (without doing as much research as he recommends), and after following the buy signals from the arrows proceeded to lose a small chunk of my investment. (You can read all about it in my forum post about INFY).

Best practice that I know of at the moment for new investors: find good companies first, then use the arrows, then if the price falls 7%, sell it all, otherwise hold on until your sell signal comes near a top.

* It’s important to realize that you’re not always going to be 100% right on every stock you pick. That’s okay! Just sell the lemons quickly and hold on to your winners until the winds start to shift.

So help me understand: You’re complaining that using the arrows doesn’t “totally remove the chance you could lose money” and that you could “lose a small percentage of your investment”. I must have missed the announcement about the method that “totally” ensures you will make money! Where do I find info on that one???

You didn’t even follow his research advice fully, you want the arrows to be infallible, you think his technical game is week — but — you make no mention of other technical indicators involved in your trade that Phil overlooked… I guess that about sums it up, wow, I guess I just have to look forward to your book to clear everything up for us, huh?!

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[…] Instead, the stock dropped along with the general market and tech sectors. Closing price yesterday was around $22.50. The chart above is from our secret BusinessWeek page (I can’t ever find this from the main navigation at BW) showing a 3-month chart of the stock with a 10-day moving average line, stochastics, and MACD indicators. The green arrows indicate typical buy signals according to the specific technical indicator it covers, and the red arrows indicate typical sell signals. It’s a pretty nice chart to use for quick checkups, when you don’t want to strain your brain too much. Of course you shouldn’t rely solely on these indicators to make your investment decisions. (For more information on these charts and arrows, please refer to Chris’ article on the subject.) […]