Technical Analysis

The Darvas Box:- A Timeless Classic

In the late 1950s, Nicolas Darvas was one half of the highest paid dance team in show business. He was in the middle of a world tour, dancing before sell-out crowds. At the very same time, he was on his way to becoming a long forgotten Wall Street legend, buying and selling stocks in his spare time researching only in Barron’s weekly newspaper and using telegrams to communicate with his broker. However, Darvas turned a $36,000 investment into more than $2.25 million in a three-year period. Many traders argue that Darvas’ methods still work, and modern investors should study his 1960 book, “How I Made $2 Million In The Stock Market”. Read on as we cover the Darvas Box trading method.

Darvas Who?
The path Nicolas Darvas took to stock market riches is unique. He fled his native Hungary ahead of the Nazis. Eventually, he reunited with his sister and they began dancing professionally in Europe after WWII. When he wasn’t performing, he spent countless hours studying the stock market. Darvas read anything he could get his hands on. He gained an understanding of the fact that stocks are risky and taking profits is the key to riches.

Darvas began his trading career in the speculative Canadian stock markets and his first purchase led to a profit of more than 200%. His initial success was short-lived, and the rough and tumble Canadian markets soon took back his profits, and then some. Several years later, he turned to the New York Stock Exchange and brought a trading mentality to the market.

Trading Philosophy
Trading was not easy at that time. Stock investing in the 1950s required a full-service broker. Buying high-quality, dividend-paying stocks was the most common investment philosophy. Commissions were high, and investors favored dividend income over capital gains. Darvas brought his unique techno-fundamental theory of investing to this market, with no consideration of dividends and clearly defined stop-loss points.

To identify trading candidates, Darvas applied a distinctive fundamental filter. He looked for industries he expected to do well over the next 20 years. In the 1950s, electronics, missiles and rocket fuels fascinated the American public. Companies in these industries would benefit from revolutionary new products that would lead to exponential earnings growth.

In thinking this way, Darvas had learned from his study of stock market history that he could profit greatly if he could anticipate the next big thing. He notes in his book that in the late 1800s, railroad companies ruled Wall Street; a generation later it was automobile companies that represented an emerging technology. Investors were always on the hunt for the something new and exciting. To find stocks with the greatest potential, his research indicated that you needed to find the industries with the greatest potential.

The Strategy
From a developed industry list, Darvas would create a watch list of several stocks from each industry. Because of the commission structure of the day, he focused on higher priced stocks. With fixed commissions, the cost of trading, on a per share basis, declined rapidly as the price of the stock increased. While this was of no concern to the buy-and-hold investor, Darvas realized that a significant part of his trading profits would be lost to commissions if he was not careful. Modern day investors can look at stock price as a filter indicating that the company has some stability – very low-priced stocks often stay low for fundamental reasons in today’s markets.

Armed with his list of trading candidates, Darvas watched for a sign that the stock was ready to move. The only indicator he used was volume, watching for heavy volume among his short list of trading candidates. When he spotted unusual volume, he would telegraph his broker and request daily quotes.

He was looking for stocks trading within a narrow price range, which he defined using a set of precise rules. The upper limit was the highest price a stock reached in the current advance that was not penetrated for at least three consecutive days. The lower limit was a new three-day low that held for at least three consecutive days.

After spotting the range, he would cable his broker with a buy order just above the top of the trading range and a stop-loss order just below the bottom of the range. Once in a position, he trailed his stop based on the action in the stock. In his experience, boxes often “piled up”, which meant that they formed new box patterns as a stock climbed higher. Each time a new box formation was completed, Darvas raised his stop to a fraction below the new bottom of the new trading range.

Turning a Profit in Lorillard
In trading, a picture is worth a thousand words, and we can look at an example from Darvas’ book to gain a clearer understanding of his method. In late 1957, Darvas was performing in Saigon and noticed a volume spike in Lorillard. He began following the stock closely by asking his broker to begin providing daily quotes.

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Source: “How I Made $2 Million In The Stock Market” (1960) by Nicolas Darvas

A. He identified Lorillard’s industry and learned that it was selling a lot of Kent and Old Gold cigarettes. While not a technology stock, cigarettes were a growth industry at this time, before the Surgeon General warning appeared on every pack.

B. He bought 200 shares of Lorillard at 27½, as it broke above the box.

C. Unfortunately, his stop at 26 was hit a few days later when the stock price went back into the box.

D. Seeing continued strength reaffirmed his conviction that the stock was going higher, and Darvas repurchased 200 shares at 28¾.

E. Confident in his selection, Darvas bought another 400 shares at 35 and 36½.

F. Continued strength after the drop in February 1958 led to another purchase of 400 shares at 38.

G. To raise money to purchase another stock, Darvas closed his entire position at 57, for a profit of more than 60% in about six months. By comparison, the Dow Jones Industrial Average gained about 7.5% over that same time frame.

The simple Darvas used to profit from Lorillard can also work in the current markets. The internet has replaced the telegraph favored by Darvas, and also provides real-time quotes, eliminating the need to wait for Barron’s to be delivered on Saturday morning. Spotting high volume breakouts is relatively simple to do, and profits like Darvas made are possible if traders apply his disciplined approach.

In Summary
Much of Nicholas Darvas’ success stems from his confidence in his trading strategy. He became proficient at managing risk and taking his profit off the table before the position had the chance to reverse.

Michael Carr can be contacted at Dunn Warren Investment Advisors

Michael Carr, CMT, is Chief Market Strategist at Dunn Warren Investment Advisors. He edits the Market Technicians Association (MTA) monthly newsletter and is associate editor of the Journal of Technical Analysis.

His work has been published in SFO, Technical Analysis of Stocks & Commodities, Futures magazine, Traders Mag (Europe), Working Money, and several web sites.

He is also the author of "Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing"

Michael Carr, CMT, is Chief Market Strategist at Dunn Warren Investment Advisors. He edits the Market Technicians Association (MTA) monthly newsletter...

tomorton

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7,205 952
Classic demonstration of how a successful formula doesn't need to be complicated, though the search for exit criteria has to continue.
 
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pennycapitalist

Junior member
39 15
Besides a method that works, what I liked about the Darvas experience was how closely his trading journey mirrored my own. He made all the same mistakes in trading that I did, but began to get it under control. Because he had a much higher income, his experience needed no long periods of capital recovery as did mine. After listening to and trading with all the expert advice, he finally realized that was the way of failure. Then he used his own observation, analyzed one of his rare wins, and started repeating what worked for him.
 

DionysusToast

Legendary member
5,963 1,497
I thought it was fairly well known that Darvas lied about the money he made.

His book was entitled "How I made $2 Million In The Stock Market" but

- He lied about the amount of money he made in the book
- He did this partly by not disclosing many of his losing trades in the period discussed in his book
- Many of his winning trades actually didn't conform to the system in his book

The amount of money he made in the period discussed in his book was $152,000, not $2 million. Darvas claims to have initially made a quarter of a million dollars from just $37k - but he failed to mention that he'd actually borrowed over a million dollars to trade with.

So the $152k he made wasn't built up from $37k but from a million dollars of borrowed money. Even then with this 15% return, it appears for some of it (not sure how much), he wasn't following his own methods...

See attached PDF.

https://www.ifa.com/articles/How_I_Made_2Mil/

"The book was re-published last year and a newsletter touting Darvas’s techniques continues to be peddled to naïve investors. While it is clear that Darvas did not make $2 million in the stock market, it is entirely possible that he made a comparable sum selling books to benighted people who actually believed that some benevolent individual who discovered the secret to attaining fantastic wealth in the stock market would be happy to share it with the whole world."
Ouch!
 

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tomorton

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7,205 952
Interesting, thanks DT.

Still sounds like a sane method, so could it work better for one of us than it did for Darvas?
 

Pat Riley

Established member
794 178
Interesting, thanks DT.

Still sounds like a sane method, so could it work better for one of us than it did for Darvas?
Isn't it just another breakout method? 3 day low or high breach? Same as Donchian (6 week channel?). You'd think if it, or any, of these methods worked there'd be more people using them.
@tomorton, why don't you consider running a journal using this method on a test case?
 

pennycapitalist

Junior member
39 15
Some people like Dan Zanger and William O'Neil seem to make money with modern versions of the Darvas Box. Come to think of it, both of these people also sell their secrets, William O'Neil in a massive way.

Livermore, almost everyone's hero, blew out his life account!

As a native American, I can see the truth in a good story, even when it is not entirely true. I seem to remember Darvas, like a lot of gamblers, counted his wins apart from his losses. Anyway, had he just turned over his earnings to a money manager, he wouldn't have made the $153,000. My brother-in-law who grew up during Darvas' time had a nice fat trust fund churned into nothing by a large Texas Bank. That was legal in those days.

Darvas found an edge on his own even if it wasn't as sharp as he wanted us to believe. That's one truth we can learn from his book. Another is to not believe every thing we hear. That one we have to learn over and over again.
 

tomorton

Legendary member
7,205 952
Isn't it just another breakout method? 3 day low or high breach? Same as Donchian (6 week channel?). You'd think if it, or any, of these methods worked there'd be more people using them.

@tomorton, why don't you consider running a journal using this method on a test case?

Got enough on my hands really Pat but I might add this to my regular chart checks for an entry signal now and then if the usuals fail me.
 

Pat Riley

Established member
794 178
Got enough on my hands really Pat but I might add this to my regular chart checks for an entry signal now and then if the usuals fail me.
It was just a thought tomorton as you seemed motivated to look into it. Highly unfashionable these days as it was used on the dailies. Nowhere near fast enough for today's busy traders. Then again, there seems to be a tendency to take any system and religiously preserve all the settings - except the timeframe - which miraculously is expected to work as effectively in the traders chosen timeframe as it did in the developers - as if this was a minor point.
 

pennycapitalist

Junior member
39 15
One might need to hurry if they want to resurrect the exact Darvas casket from the grave. Wire services are hard to find these days :)
 

timsk

Legendary member
6,921 1,799
Some people like Dan Zanger and William O'Neil seem to make money with modern versions of the Darvas Box.
. . . And the thing that unites them all is that they managed to unearth massive growth stocks. William O'Neil developed his 'CAN SLIM' strategy and Dan Zanger achieved it by trading tech stocks right up to the dot com bubble bursting in 2000 whereupon, allegedly, he lost $5 million in a single day.

I read Darvas years ago and I forget which were his really successful trades - Polaroid was one I think - and possibly Lorillard referenced in the article - may be another. Whether it was luck or skill is open to debate but, essentially, he made the bulk of his money in just three or four stocks. Traders of today attempting to repeat the same trick will struggle to find major growth stocks by scouring the constituents of the FTSE 250 or the S&P500. There will be massive growth stocks out there somewhere obviously, but they are unlikely to be lurking in the major indices or to be uncovered using a simple TA pattern. Additionally, as the article makes clear, Darvas placed great emphasis on heavy volume when price was trading within a tight range. I'm not a volume expert - far from it - but I suspect Darvas' simple approach to volume wouldn't work very well in today's markets. The reason being that trading today is a totally different ball game to what it was back in Darvas' day and volume isn't so straightforward to interpret now as it was back then.

For me, the key thing to learn from Darvas is not so much the box technique itself, but that he developed a simple methodology that he stuck to rigidly. The lesson has more to do with discipline and focusing on risk and trade management - than it does on entry technique - which I doubt is any better or worse than any other.
Tim.