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Nicolas Darvas - Box Trading Method

Updated: May 25, 2021

Nicolas Darvas - The Darvas Method - Professional Stock Trader



Nicolas Darvas.

Author of ‘How I Made 2 Million Dollars In The Stock Market’

A professional dancer who later turned into a professional stock trader, famous for what is now known as the ‘Darvas method’

Fundamentally, a trend following system with an eye on price and volume.

Originally published 60 years ago. Darvas turned $10,000 into $2,000,000.

To put the performance into perspective, if we considered inflation, the title of the book would now likely be called How I made 46 Million in the Stock Market.

How did he do it? Let’s take a look.

We present ‘How I Made 2 Million Dollars In The Stock Market’ by Nicolas Darvas.

Darvas, originally from Hungary, trained as an economist in the University of Budapest.

When he wasn’t dancing, Darvas read over 200 books on the markets spending as much as 8 hours per day studying.

He attributes much of his success to the methods taught by Jesse Livermore, and with some tweaking he created what he calls the ‘Box System’. We look at the specifics of this system and apply it to some more recent stocks to see if it has stood the test of time.

Many traders and investors alike try to buy at the low and sell at the high, in theory this is sound advice but in real life it is almost impossible.

Darvas says;

“I never bought a stock at the low or sold one at the high in my life, I am satisfied to be along for most of the ride.”

As we will discover in the video, Darvas only seeks to capture some of the move and with good money management he is able to capture large, unpredictable increases and avoid large, unpredictable declines.

Let’s look at a chart example presented in the book in which Nicolas Darvas traded and applied his box strategy.

Here we see the company Lorillard, and although presented on a weekly chart, Darvas says the strategy can be used on any time frame.

Darvas learned that Lorillard had been selling huge quantities of Kent & Old Gold cigarettes.

Cigarettes were a high growth industry at the time, and Lorillard’s stock reflected this with high demand. Seen here at point A with a spike in volume.

We will look at the formation and criteria of the box strategy in more detail shortly, but first let’s apply the boxes Darvas used on the chart here.

Darvas recognised that a box had formed, and price broke through the upper part, seen here at point B, accompanied by high volume.

At this moment he purchased 200 shares at a price of $27.5 for a position size of $5500.

He also placed a stop order at a price of $26 here at point C.

This gave a stop loss of 5.45%, equivalent to $300 against the position.

The price eventually dropped below the high of the previous box and hit the stop loss for a loss of $300.

The price ended the week with a close above the box, again on high volume, Darvas then re-entered the position here at point D with 200 shares at a price of just under $29. The stop loss was placed in the same position with a potential loss of $400.

Further purchases were made here at points E and F before finally selling at $57.

For calculation purposes, we only include the box breakout purchase at point D, giving a near 100% profit of $5500 in 6 months, from a trade risk of $400.

This gave a risk reward ratio of 14 to 1. In comparison the Dow Jones only increased by 7.5% over the same period.

Other than the box entry method itself, the underlying message here is that by focusing on the risk, you set the platform for excellent rewards.

Let’s move onto the box formation and criteria Darvas uses.

The first point to make is that the initial stage of a box must be formed by a new 52 week high. This would represent the top of the box, and if price retreats, the 52 week high would be classed as resistance.

The point at which price retreats and recovers is called support. This process repeats until we see a box formation made up of numerous support and resistance points.

Once an obvious box formation occurs, Darvas says to set a buy order a few points above the resistance line. Therefore, if price broke out of the box your trade would automatically trigger without the need to constantly check price.

Simultaneously a sell order should also be placed within the box, this will instantly define the level of risk you are willing to take, perhaps 5%.

Darvas makes a superb quote on stop losses and risk management when he says:-

“If you could play roulette with the assurance that whenever you bet $100 you could get out for $98 if you lost your bet, wouldn’t you call that good odds?”

This is such a strong statement which is not fully understood by beginning traders. Let’s look at this in its simplest form.

Darvas quotes the word ‘odds’ or often referred to as probability. In his example of roulette (assuming there were no zeroes), If we were to make a $100 bet, there would be a probability of 50% as to whether the ball would land on red or black.

In other words, you risk all your $100 to win $100 or you risk 100% to win 100%.

So how does this relate to trading and how does Darvas allude to us being able to move the odds in our favour?

In roulette there are no logical reasons as to why the ball would fall in either colour, its pure luck. Unlike trading, there are no resistance points on the roulette wheel suggesting one colour has a better chance than the other.

Let’s begin to categorise each scenario into gambler, novice trader and professional trader.

We know in this example, we have a 50/50 chance and no control over risk or reward, therefore this is simply gambling.

Next, we have the novice trader who is able to understand some of the equation.

They understand through price action that the breakout of resistance and the forming of support thereafter, can provide a logical reason to enter a trade whilst putting the probabilities in their favour. Or in roulette terms, the likelihood of the ball staying in black rather than red and achieving a 100% return has improved.

However, without a stop loss the novice trader still takes 100% of the risk, just like the gambler. An improvement, but not the optimum strategy.

Next, we have the professional trader.

Like the novice trader they understand the importance of support and resistance, however the professional trader will also limit their downside risk by placing a stop loss.

Using the 2% Darvas quoted, we might place the stop loss here, providing 100% or more upside and 2% downside.

To recap, the gambler has no way of improving probability, and no risk control.

The novice, applying the box strategy, can improve his probability but has no risk control.

The professional, also applying the box strategy, improves the probability and limits any downside risk.

Now we understand the logic, let’s apply the box strategy to a recent stock.

Here we see the popular stock Amazon, from 2016 to 2019.

In 2016 we see a 52 week high here, followed by a bottom here.

This creates the upper and lower lines of the box as we watch it form over time. The point of entry would be when the price is seen to breakout above the box, seen here.

A stop loss would be placed a few percentage points within the box, perhaps here.

The trade would remain in play until the initial stop loss is hit, or until another box is formed, at which point Darvas would raise his stop and add another position. This is also known as pyramiding.

As the trade progresses, we look for signs of another box formation.

Here we see another 52 week high and a retracement to a bottom, again we can plot the beginnings of a box and watch it form until we see a breakout.

We see the breakout, enter the trade with some more capital and raise the stop accordingly.

This process repeats until the trend eventually comes to an end.

Here we see price increase without any obvious signs of a box formation, then turn down and cut through the raised stop loss.

On closer inspection it could be argued that a box formed at the very top of the trend, seen by a top and by a bottom.

At which point the stock would have been sold as it pierced through the bottom of the box.

In terms of risk reward and taking the first box trade in isolation, we can see the risk taken is remote in comparison to the eventual reward.

The risk reward ratio in this example would have been approximately 12 to 1.

This is the recipe for success in the markets and is the exact process Nicolas Darvas took to earn millions.

Today we found a qualifying chart from a company called Genus.

We see a 52 week high and a retracement to a low, at which point we can form a box and once again watch it develop.

Darvas suggested that we place a buy order a few points above the box in anticipation of a breakout. The breakout occurred at the close of this week so it will be interesting to see how it develops.

A stop loss would be placed within the box at a percentage you are comfortable with, perhaps here.

Not forgetting that Darvas also wants to see some conviction on the breakout, as such he likes to see volume increase, which we do here.

In my review of the Nicolas Darvas method, I have found the following.

Darvas is predominantly a chartist, a trend follower, an excellent risk manager and combines everything to put the odds of success in his favour.

His box strategy encapsulates this into a fairly simple process and promotes discipline through its objective approach.

I leave you with this final quote from Darvas;-

“I have no ego in the stock market, “If I make a mistake, I admit it immediately and get out fast.”

The book offers a time-tested strategy and story of brilliance, as such I give it 5 stars and recommend it to all levels of trader experience.

Thanks for listening. Please hit the like button and let me know your thoughts in the comments below.

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1 commentaire

I've just skimmed this book, and what I found most compelling is his story about almost going bust on several occasions. This book came out around 1960, but the story and its message holds true today.

Ego and confidence clearly got in the way, as did too much noise from talking to other brokers and traders.

The message though is clear, create or find a system, take ego and emotion out of the equation and test the system. In other words, use triggers and rules and be careful with the numbers.

It would appear he started out as a studier of stock fundamentals and only later on after a few near disasters did he move to a more technical analysis.

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