Darvas Box - Super Trader System

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Darvas BoxTradingLegacy of a Super Stock TraderDarvasBoxFrank Watkins

Darvas Box TradingThe Nick Darvas story is unique for many reasons. Firstly, itis a true story, well documented and authenticated at the time of hisinterview with Time Magazine. Darvas did not have insideinformation or work within the financial industry, nor was he somesort of financial whiz kid; in fact, he was one half of the world’shighest paid ballroom dancing team.The difference is that Darvas was always working on theultimate trading plan, incorporating risk management rules thatwould finally lead him to amass a small fortune within a few years.AcknowledgementsI would like to thank Deidre from Darwin for bringing NicolasDarvas to my attention. I also wish to acknowledge fellow trader andauthor Darryl Guppy, who has done much to bring the work of NickDarvas to the attention of traders throughout Australia and Asia.Pro Trader Training Media Pro Trader Pty Ltd 20032

Legacy of a Super TraderTable of ContentsACKNOWLEDGEMENTS . 2TABLE OF CONTENTS . 3TABLE OF FIGURES . 4BACKGROUND . 5BACKGROUND . 5THE DARVAS STORY: A SYNOPSIS . 6Darvas the Gambler. 6No pets Rex. 6Darvas the Fundamentalist. 7His First Crisis. 9Darvas the Technician . 10The World Tour. 12Broking Terminology . 12The Theory Starts to Work . 13The Second Crisis. 13Making Two Million Dollars. 14“REDISCOVERING” DARVAS . 15Will Trading Darvas Style Work for You? . 15DARVAS IN PRACTICE . 17Your First Darvas Scan. 17Darvas Box Construction. 18Choosing Your Stocks . 19Do Your Homework . 20Calculating the Breakeven Level . 20Optimising the Breakeven Level . 21Analysing the Trade . 22Placing Your Order. 22Managing Your Trade. 23Pyramiding the Position. 24Will it Work in Today’s Market?. 25Pro Trader Training Media Pro Trader Pty Ltd 20033

Darvas Box TradingTable of FiguresFigure 1 Darvas' Pyramiding Boxes . 11Figure 2 Selecting the Darvas Scan . 17Figure 3 Darvas Scanner Dialogue Box. 17Figure 4 Anatomy of a Darvas Box . 18Figure 5 Darvas Box Sequence #1. 20Figure 6 Darvas Box Sequence #2. 23Figure 7 Darvas Box Sequence #3. 24Figure 8 Darvas Box Sequence #4. 25Pro Trader Training Media Pro Trader Pty Ltd 20034

Legacy of a Super Trader1BackgroundThe Darvas story is unique in that there is no mystery as to howhe made his fortune. Unlike other theories put forward by so-calledmarket gurus there is no need to spend years attempting to unravelsome mystical form of analysis. You can trade like Darvas today!Simple, practical and logical is the best way to describe “The Darvas BoxTheory”.Darvas’ story and his trading technique were described in his firstbook1. His method, like all good systems is simple and founded in logic.All that is required is the discipline to follow it. Darvas’ discipline wasremarkable, this coupled with his ability to analyse himself as well as themarket was the root of his trading success. Through his self-analysis hecame to realize that “his ears were his worst enemy”He amassed his fortune without the help of computers, mobilephones, fax machines or any of the communications technology we haveat our disposal today, indeed he only had access to end-of-day data. Allof his trading decisions were made outside trading hours, not sittingwatching a live data screen all day. Starting with a purchase of only 3000 worth of stock, Darvas amassed a fortune of over 2.2 milliondollars. This was in 1959 and would be equivalent to over 20 milliondollars today.A truly remarkable aspect of the Nick Darvas story is that he wastravelling extensively on a world tour when he developed his trading plan.He was isolated from all external influences such as telephone,newspapers, brokers and other sources of so-called useful information.Let’s look at how Darvas succeeded.1How I Made 2,000,000 In The Stock Market (1986, Lyle Stuart KensingtonPublishing, New York)Pro Trader Training Media Pro Trader Pty Ltd 20035

Darvas Box Trading2The Darvas Story: A SynopsisDarvas the GamblerDarvas did not set out to be a gambler; in fact he took hisinvesting very seriously.“Darvas the gambler” is Darvas’ owndescription of himself once he realized that his approach to investing wasno better than gambling. His story begins in November 1952 in Canadawhen he and his partner were asked to appear in a Canadian nightclub.Rather than pay in the normal fashion, Darvas was offered 6000 sharesin a company named Brilund, a stock that was quoted at 50 cents at thetime.Despite not being able to keep to the arrangement, Darvasbought the stock anyway and paid 3000. Thinking no more about theshares, Darvas was idly skimming the financial press some 2 monthslater and saw Brilund quoted at 1.92. I believe that Darvas was“hooked” from that moment on. An 8000 profit in two months wouldmake most people salivate.Working in nightclubs led Darvas to meet various wealthy peoplewhom he asked for advice.“So I asked them, do you know a good stock?Oddly enough, everybody did seem to know one. It wassurprising. Apparently I was the only man in Americawho did not have his own first hand stock marketinformation. I listened eagerly to what they had to sayand religiously followed their tips. What ever I was toldto buy, I bought. It took me a long time to discover thatthis is one method that never works”.Darvas sought the services of a broker and spent the next yearhappily buying and selling stocks. In his words he “ jumped in and outof the market like a grasshopper”.No pets RexThis is not a reference to dogs and cats, rather a very strongwarning for all traders. Darvas developed a special liking for somestocks, some because they were given to him and others because hestarted making money with them. They became “pets”, and he sang theirPro Trader Training Media Pro Trader Pty Ltd 20036

Legacy of a Super Traderpraises but this mentality lasted until he realized that the pet stocks werecausing the biggest losses. As with most people who have traded,Darvas found that he was taking small profits and holding onto largelosses.While Darvas was excited by the whole industry, delighted witheach small win and overlooking his losses, he was not generally tradingprofitably.“It was a period of wild foolish gambling withno effort to find the reasons for my operations. Ifollowed hunches. I went by god-sent names, rumours ofuranium finds, oil strikes, anything anyone told me.When there were constant losses an occasional smallgain would give me hope, like the carrot before thedonkey’s nose”.By the end of 1953, the original stake of 3,000, plus the 8,000profit from Brilund, had been whittled down to 5,800. Disillusioned butundaunted Darvas decided to give up the Canadian market. He moved tothe greener pastures of New York and the allure of Wall Street.Darvas the FundamentalistDarvas severed all ties with the Canadian market and decided tostart afresh. He topped up his account to a nice round 10,000. Afterdoing his homework Darvas finally decided to dip his toes into the WallStreet market and start trading. His first step was an obvious one andsomething that no doubt most people have tried without much success.He rang his new broker and:“Trying to be the old financial hand, simply asked what wasgood. I realize now this enquiry was more suitable for a butcher butthe broker was up to it. He suggested several safe stocks”A few of those stocks began to rise immediately and Darvas wassure that he was on the right track with his new broker. Darvas felt thatthe broker’s advice was no longer in the “hot tip” category but was validnews based on sound logic and current economic events. Darvascontinued to trade constantly. Unfortunately his early success was dueprimarily to a bull market rather than any wonderful broker research orother insight into the market. It would have been difficult not to choosethe odd stock that was rising.Pro Trader Training Media Pro Trader Pty Ltd 20037

Darvas Box TradingBuoyed by his apparent success Darvas began to study books onmarket terminology and how to trade successfully. He subscribed to asmany newsletters and tip sheets as he could find. He became avoracious reader of all things financial. Slowly he began to question thevalidity of these newsletters. They often contradicted each other; a buy inone tip sheet or newsletter was a sell in another.Compounding his problems Darvas began to realize thatbrokerage became a major part of each transaction as he jumped in andout of stocks. This led to the realization that many of the old marketadages2 were of no relevance, like “you cannot go broke taking a profit”,of course you can, if your profits are smaller than your losses, or “buycheap, sell dear”. This was sound logic to Darvas so off he went to buy“cheap” stocks, or stocks that were a bargain and undervalued. Darvasfound that these stocks “stuck to his fingers like tar”.Through all these experiences Darvas began to reach certainconclusions. Unlike most potential traders he learned from each seriesof mistakes. Darvas began to outline some rules that would ultimately bepart of the overall plan that led to his great success.1. I should not follow advisory services. They are not infallible, eitherin Canada or on Wall Street.2. I should be cautious with broker’s advice. They can be wrong.3. I should ignore Wall Street sayings, no matter how ancient andrevered.4. I should not trade over-the-counter – only in listed stocks wherethere is always a buyer when I want to sell.5. I should not listen to rumours, no matter how well founded theymay appear.6. The fundamental approach worked better for me than gambling. Ishould study it.(How I Made 2,000,000 In the Market, p.34)2These market adages are explained in greater detail in Frank Watkins’book “Exploding the Myths – What your broker doesn’t know or won’t tell you.”Pro Trader Training Media Pro Trader Pty Ltd 20038

Legacy of a Super TraderFor months Darvas studied company fundamental information,sifting through dividends, net tangible assets, market capitalization,assets, liabilities and price-earnings ratios. He developed a “wish list” ofwhat he wanted a company to have. Stocks that the experts liked, stockswith a strong cash position but selling below book value and companieswho had never cut their dividend.His First CrisisAfter an enormous amount of research Darvas decided the steelindustry would be the one to make him rich. Playing it safe he decided tobuy a stock in the steel sector and paying a good dividend. Furtherresearch led Darvas to the purchase of 1000 Jones and Laughlin sharesbecause:1. It belonged to a strong industry group.2. It paid almost 6% dividend.3. Its price-earning ratio was better than any other stock inthat group.Darvas had such faith in his analysis that he mortgaged a block ofland, borrowed against an insurance policy and bought on a 70% margin.His cost was 52,652.30 (1000 shares at 52 ¼.) This purchase wasmade on 23rd September 1955.On 26th September 1955 this fool proof theory began to unravelas Jones and Laughlin started to drop. Like most traders he wasstunned, paralysed like a rabbit caught in a spotlight. What to do? Basedon all the best work Darvas could come up with, J&L was “worth 75.00”.Most traders and brokers decide to hang on when a crisis hits.Darvas was no different. He employed the BHP method. (Buy, Hold andPray) As prices continued to slide he was almost too scared to check thelatest quote.Finally Darvas decided to sell, his loss was over 9,000. At leastat this point Darvas was different from most traders I have seen, he didtake a loss, but most importantly, he preserved some of his capital.Many traders wait five, or ten years for some sort of recovery, more oftenthan not, they wait until the company enters bankruptcy.Pro Trader Training Media Pro Trader Pty Ltd 20039

Darvas Box TradingGambling, tips, research, investigation, whatever Darvas tried didnot work. He became desperate. Three years had gone by.Eventually, Darvas noticed a stock, Texas Gulf Producing. Heknew nothing about it and had heard no rumours. He simply noticed thatthe price was rising. Darvas bought Texas Gulf and recouped half thelosses from the J&L disaster.“What, I asked myself, was the value ofexamining company reports, studying the industryoutlook, the rating, the price-earnings ratio? The stockthat saved me from disaster was one about which Iknew nothing. I picked it for one reason only - itseemed to be rising. Was this the answer it couldbe?”Darvas the TechnicianIt was time for further reassessment. Darvas admitted that hehad tried fundamental analysis without success. However technicalanalysis had led to profits. He decided to try the successful approachagain. He noticed a stock called M&M Woodturning, none of the financialinformation services could tell him anything and his broker had neverheard of it. He remained interested because the price action remindedhim of Texas Gulf Producing.In December 1955 the stock rose from about 15.00 to 23.50.After a five-week lull in activity, the price began to climb again,accompanied by an increase in volume. Darvas bought at 26.60. Theprice continued its rise and Darvas sold at 33.00. Again, he knewnothing of the stock other than the price was rising. Following his sale ofM&M Woodturning Darvas found a newspaper report that a takeover wasbeing secretly negotiated.This was a major breakthrough. Darvas was ecstatic, feeling likean insider without being one. This experience convinced Darvas that apurely technical approach was logical. Studying price action and volumecould get positive results.Darvas began buying stocks solely on the basis of an increase involume and price. Sometimes this was successful and sometimes not.He found that on occasions he would buy a stock only to see itimmediately begin to fall, and as soon as he sold, prices would advance.Pro Trader Training Media Pro Trader Pty Ltd 200310

Legacy of a Super TraderSounds familiar doesn’t it? As Darvas continued to study books andcharts, he realized that price movement was not random, in fact oncestocks had a defined upward or downward trend, that trend tended tocontinue for some time.Within those trends, stocks moved in a series of patterns or whatDarvas called “boxes”. This was the beginning of the “Darvas BoxTheory” which was to lead him to millions of dollars.“This is how I applied my theory: When theboxes of a stock in which I was interested stood like apyramid, on top of each other, and my stock was inthe highest box, I started to watch it. It could bouncebetween the top and bottom of the box and I wasperfectly satisfied.Once I had decided on thedimensions of the box, the stock could do what ever itliked but only within that frame. In fact if it did notbounce up and down I was worried, no bouncing, nomovement meant it was not a lively stock”.4241403937363534Figure 1 Darvas' Pyramiding BoxesDarvas bought his shares when prices broke out of the top of thebox. While this method greatly improved his entry levels, this system stilldid not lead to each trade being correct and profitable. At this pointDarvas realized that there was no sure thing in the market. He alsorealized that he could not take chances, he would need to reduce risksas far as possible. With this in mind Darvas decided to employ anautomatic stop loss system.Pro Trader Training Media Pro Trader Pty Ltd 200311

Darvas Box TradingFurther reflection led Darvas to re-define his objectives. Right stocks Right time Small losses Big profitsHis best weapons were: Price and volume Box theory Automatic buy order Automatic stop-loss sell order.The World TourAt this stage Darvas faced a new dilemma, he signed a two-yearcontract for a world dancing tour. How could he continue to trade?Through discussions with his broker, Darvas agreed on one tool. Thebroker would airmail the weekly Barron’s financial publication to Darvas.From this Darvas could study prices and follow any rising stocks. Eachday the broker would send a cable to Darvas with the open, high, lowand close of stocks that Darvas was interested in.Darvas felt this was like playing poker but he could not hear thebetting, he could not see what was going on, however he did hold thecards.Broking TerminologyAutomatic buy order:The way in which an automatic buy order works is quite simple.In Darvas’ case his entry needed to be at a level when prices burstupwards through the top of a period of consolidation, or the top of theDarvas box. If the top of a box was 35.00, Darvas would give his brokerPro Trader Training Media Pro Trader Pty Ltd 200312

Legacy of a Super Traderan instruction to buy the stock any time in the future that the stock tradedat say 35.25 cents. This order may have been transacted weeks later, ifat all. If the price did not continue to advance the purchase was notmade. This method ensured that at least at the time of entry, prices wererising.Automatic stop-loss sell order:At the time of entering a stock, Darvas would place an order tosell if prices traded below a certain level. The advantages of thisstrategy are enormous; it means that all risk is defined prior topurchasing any stock.The Theory Starts to WorkIn November 1957 while touring in Saigon, Darvas noticed astock called Lorillard. There was a bear market at the time but this stockwas rising. The stock had risen from 17.00 in the first week of Octoberthen consolidated between 24 and 27. Volume had increased fromaround 10,000 per week to

Darvas’ story and his trading technique were described in his first book1. His method, like all good systems is simple and founded in logic. All that is required is the discipline to follow it. Darvas’ discipline was remarkable, this coupled with his ability to analyse himself as well as the mar

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