The Simple Trading Gem of the Darvas Box Method
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It’s time to be Introduced to the Darvas Box Method. After years of trial and error, Nicolas Darvas perfected one of the most successful trading methods of all time. But what made his system so unique was the amount of money that it brought in. Darvas himself was often shocked at the profits his system made. Yet even with these profits aside, the most important point about his system is how easy it is to apply it.
The essence of Nicolas Darvas’ method was to identify stocks that were on the rise, using only the price action and volume of a stock. Although Darvas didn’t consciously set his method up this way, he created a simple way to calculate a volatility range. Normally, finding volatility ranges is an extremely complicated calculation. Yet working with nothing but the price action and range of a stock, Darvas was able to calculate a reliable volatility range.
Darvas’ method is probably one of the most successful trading strategies ever created. Research has shown that his method is effective almost fifty percent of the time. This is an incredible success rate for stock market transactions. The market is unpredictable, so any method that is successful that often is outstanding. What makes Darvas’ method even more outstanding is the attention it takes towards preserving capital. Anyone can make money on a rising stock, but few methods are this reliable when it comes to preserving capital. Darvas’ stop-loss order is what makes his method the method of choice for many professional traders.
The box method identifies trends where already bullish stocks are getting stronger. The Darvas box method is referred to as a trend trading technique because traders look for stocks that are establishing strong upward trends. The main objective of trend trading is to identify a stock that already has a great deal of bullish strength. Buying into an already strong stock reduces the risk that the trend will collapse and the price will fall. Identifying an already strong trend also allows a trader to monitor the stock on a less frequent basis, especially with disciplined use of the stop-loss order.
Although the Darvas box method has all the advantages trend trading has to offer, some traders believe there are disadvantages. For many traders, the valuation of a stock is the most important piece of information they use in choosing a stock. But when developing the box method, Darvas paid no attention to the valuation of a stock. For many traders, it will be difficult to ignore valuation and other popular indicators. As a rule of thumb, the valuation
of a stock should not be a factor in trading.
Valuation is simply an opinion of ‘experts’, and these ‘experts’ are often wrong. Stocks valued highly often fall, and stocks with low valuations will often rise. The groupthink of the market is what really sets the price of a stock. A stock is worth whatever people in the market are willing to pay for it, and this price rarely reflects what the stock’s valuation says it’s worth. Trend trading takes advantage of people in the market who are willing to pay high prices for a stock.
Darvas’ Method is a perfect illustration of ignoring opinions and working with facts.
Some traders believe that a disadvantage of trend trading is that the methods will not capture the entire trend. And it is true that no trend trading method will ever capture a trend in its entirety. Some profit will always be lost before buying into the trend and at the termination of the trend. However, there is no system that will capture an entire trend. There is no such thing as a perfect trend trading system. Many traders search for systems that are perfect, but they are continually disappointed.
It is important to note that trend trading is not simply buying new highs. Buying new highs without any other reason for entering a position is an extremely risky strategy. New highs, especially highs for a 12 or 6 month period, are more often than not followed by a swift and deep decline. A new high will often reach its height for reasons other than solid support. Rumors, marketplace hype, insider trading, and inside tips that become public will often spur a rally. Unsupported, this rally will only collapse once the market realizes there is no reason for the new high price. Darvas ensured, in his method, that a stock’s new high would be supported by a volatility range that indicated the price was where it belonged.
Volatility refers to how much the price of a security will fluctuate. A volatility range is the range in which a stock’s price will move. A stock with high volatility can change price drastically over a short period of time. There are a multitude of factors that affect a stock’s volatility. But Darvas’ ignored the factors and conditions that made a stock volatile. He simply tried to pin down an exact range based on price, and then based his actions on that range. This is the essence of the Darvas box method.
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