Darvas Box: Overview, What It Is, Limitations, And Examples
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As always, traders make efforts to work with a strategy that grows their accounts. By account growth, we mean the context of protecting capital, exiting loser trades at the earliest opportunities, while closing with big profits for winning trades.
One rare yet logically proven approach is using the Darvas Box. So, you’ll not find this strategy so common out there. However, as part of our holistic approach, we’ll invite Ezekiel Chew to share his wealth of experience about it.
Ezekiel Chew has over two decades of trading in the financial markets. And many traders – retail and institutional seek his insights to help them grow their trading skills. In this post, readers will get to know more about the Darvas Box. More specifically, how it came about and the examples of it in use.
Towards the end of the post, there’s a key section on its applicability in current markets. Plus, a collection of the limitations traders are bound to face when using the Darvas box. To sign off will be the FAQ’s section.
What is a Darvas Box
The Darvas Box is a trading theory arising around the 1950s. Ideally, it’s a technical analysis strategy that derives from its developer – Nicolas Darvas.
In appearance, the Darvas box is drawn as a simple rectangular formation. On the left side, it spans between two swing positions. Towards the right, the box captures a relative swing between high or low prices.
Darvas was a professional ballroom dancer before he took on a very successful trading career. In practice, the Darvas box strategy involves working with stocks with exclusively high trading volumes.
So, other than the volumes being key, the prices form slightly higher highs within a zone of sideways markets trading for consecutive days or time frames.
Analysts classify the Darvas box as a trend-following system. Instead of anticipating moves, it takes on a model that is more reactive versus predictive ones.
So Darvas only limited positions to stocks after making confirmation of uptrends. Essentially, price break anticipations were an anticipation of swinging from low zones of consolidation to zones of higher highs.
It’s said that Darvas did the analysis using the boxes on charts. All this was while he went along on tours in pursuit of his dancing career.
Logically, Darvas would locate a stock from his watchlist. Let’s assume the prices were oscillating inside the box at highs of between $35 and $40. Darvas would allow for a bullish break confirmation past the price mark of $40.50 for assurance of the moment to take buy positions.
How Does Darvas Box Theory work
Nicholas Darvas used to approach markets from a watch list for a specific industry. At his time, commissions were relatively high, so his strategy was to work with stocks with very high relative prices.
Markets had a constant commission structure on the basis of per share of stock a trader held. Therefore, the commission rate of decrease was very high, given that the share price kept rising.
Accordingly, the commission structure would have a nil effect on investors with a buy-and-hold strategy. Of course, the cost passes to the next holder on the line of ownership. So Darvas was aware that commissions were a leeway to reduce his profits over an extended period.
Therefore, the choice of Darvas to stick to high-value stocks worked in his favor. At current times, investors stay away from stocks with relatively too low prices. It arises as a form of fundamental reason – which also tends to keep investors away.
So Darvas’ ability to narrow down to the watchlist is also a great indicator of his approach. With a list of few candidate stocks, the next step was watching for the signs of breaks in prices.
To make matters simple, Darvas watched the volumes of stocks – of course, with limitations to those on the watchlist.
Next, whenever Darvas spotted unusually higher volumes, he made contact with the brokers, ordering daily quotes.
Also in place of the screening process was an elaborate and precise set of rules for price monitoring:
- First, prices on the upper limit applicable per stock were the price score within a current move. The prices would also not have been hit over the past timeframe of three days back-to-back.
- Applicably, a lower price limit was the lowest point for the last three days – also picked consecutively.
Once a range was clear, Darvas made contact with the brokers for buy orders – at prices slightly higher than the trading range within the rectangular zone. His top loss orders were as usual – slightly below the range marked by the range.
While positions were picked, Darvas would trail the positions with a stop loss order.
According to his insights, Darvas noted the tendency of boxes to pile up. Meaning that price action would form other boxes higher up in tandem with price increases per stock.
So, Darvas would draw newer boxes at higher levels of price action and set stop loss orders with each (entry and exit points).
Limitations of the Darvas Box Trading Strategy
As we see, Nicholas Darvas was able to make huge profits using the strategy. As a matter of fact, the claim stands that he made an investment of $2,000,000 in the stock markets from the capital of only $10,000.
However, in reality, every strategy has some downsides. So, here are the situations in which Darvas box trading strategy can push investors into overly tight spots:
- Opening positions into breakouts of bear markets. Most probably, the investor will lose the capital up to the range set for the stop-loss position. Else, without the SL position, the losses can be devastating. Of course, at an extreme point, the investors may have to lose the entire capital in the account at the worst.
- As part of the addition to the above, ignorance of reasonable stop loss positions is a highly risky scene for the Darvas Box strategy.
- Adding more position at unreasonable portions. This applies when investors add more trades to increase profitability – in the hope that market trends remain in place. What happens when markets reverse course while a trader holds higher lots? More losses.
- The Darvas box theory strategy is a very risky strategy for s consolidating or sideways market. As we mentioned earlier, it best fits with trending markets.
On the last point under this section, many analysts believe that Darvas was simply a lucky coincidence. The key reason to support this arises from the fact that his fortune was a coincidence with bullish markets.
Insights from Modern Stock Market on the Darvas Box Indicator
The Darvas box theory may have been applicable in stock markets long ago. The current scenario sees markets swing up and down with random fashions due to the underlying information.
At current times, information travels rapidly. However, there are very handy insights that the modern trader can pick for Nicholas Darvas and his strategy.
Here are three key scenarios where the Darvas box strategy can be of great help:
First is paying a keen eye on markets that are emerging
The perception here is that there’s real information yet to get into the hands of all prospective investors. So good stocks appreciate or retain a bullish market bias over the inception years.
The second is riding on volumes of stocks traded
Of course, volumes are a pointer to high liquidity. It’s a combination that helps market prices move, and traders can readily tap into the insight behind it.
Third is the use of an exit mechanism – in case things go wrong
Darvas was keen to use the stop loss order positions. That way, he was able to protect the larger portion of capital – for trading other opportunities at subsequent timeframes.
Ideally, at present, trading volumes matter. By inference, high volumes are an indicator of higher demand for any underlying asset.
Darvas is a clear indication that market chart analysis has been around for quite a long time. The advantage of the present is the ability to decipher complex market shapes and patterns using software.
The Darvas theory is keen on the point of market entry. It combines technical analysis alongside the momentum of the prices. In actual application, bullish markets form higher Darvas boxes over subsequent time frames.
Lastly, as you can see, Darvas did follow some key investing rules. The point is picking on those applicable to the current times and building other winning strategies on top of them.
Examples of How Darvas Boxes Are Created in Trading Stocks
Since the Darvas Box Theory builds on price action and volumes, it qualifies as a technical analysis trading strategy.
And from the look of things, Darvas wasn’t a novice trader. He was an investor who had a firm grasp of fundamental analysis and a reasonable risk management strategy. Ideally, fundamental analysis brings onboard qualitative and quantitative factors before making investment decisions.
Again, Darvas was picky. Only concentrating on a few stocks or target stocks from the financial markets – only investing in well-performing stocks only.
In a nutshell, if a stock price oscillates within a “price box” ranging from $22 to $28, a bullish bet once the price breaks towards $30 are reasonable. And in any case, a pullback takes place – your cover is a stop-loss order. And all the same, bear in mind that the general trend retains the bullish bias.
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Conclusion: Darvas Box Theory
Darvas box is a technical trading strategy that picks after the name of its founder – Nicholas Darvas. It dates back to the early 1950s.
It came about in a surprising turn of events – Darvas was able to build an excellent trading career. He would make analysis on target stocks and make orders as he went about his roadside career as a professional dancer.
Ideally, Darvas’ trading involved the location of rising boxes above a current one. So stop losses would shift slightly higher to lock profits as far as the trend could hold.
According to reports, he was able to transform capital accounts from $ 10,000 to $2,000,000, quite significant milestones back in his time. Critics argue that his strategy was a coincidental occurrence as it only fits more precisely within bullish markets.
However, there are a few great points traders can pick from Darvas. His use of trading tools and clear entry and exit criteria. Next is the stop loss order. Plus, careful market analysis – which stands out.
Darvas Box Market Momentum Theory FAQs
Is Darvas Box effective?
Yes, the Darvas box strategy remains an effective way to analyze and earn profits so long as the investors follow its correct stock market rules.
One key downside is the low effectiveness of the strategy with bearish markets. Of course, some critical rules apply across the board, like correct risk-to-reward approaches.
How do you use Darvas Box Theory as a Technical Analysis Indicator?
In summary, using the Darvas box strategy works; investors watch an asset for over a year to locate the formation of a new high. Next is a waiting period of 3 days – If prices do not exceed the new high.
The market entry comes in where the market breaks past the set new high point – which turns into a low of the next formation of a Darvas box. Traders join into the breakout with the cover of a stop loss order.