What is the Darvas box theory?
Darvas’ box theory is a trading strategy developed by Nicolas Darvas to target stocks using highs and volumes as key indicators. Darvas developed his theory in the 1950s by traveling the world as a professional ballroom dancer. Darvas’ trading technique is to buy stocks that trade at new highs and draw a box around recent highs and lows to establish the entry point and the placement of the stop-loss order. A stock is considered to be in a Darvas box when the price action exceeds the previous high but falls to a price not far from that high.
Key points to remember
- Traders applying Darvas’ box theory target stocks with increasing trading volume.
- The Darvas box theory is not locked in a specific period of time, so boxes are created by drawing a line along the recent ups and downs of the time period used by the trader.
- Darvas’ box theory works best in a rising market and / or targeting bullish sectors.
What does the Darvas Box theory tell you?
Darvas’ box theory is a type of momentum strategy. Darvas’ box theory uses market momentum theory as well as technical analysis to determine when to enter and exit the market. Darvas boxes are a fairly simple indicator created by drawing a line along the ups and downs to create the box. When you update the ups and downs over time, you will see drop boxes or drop boxes. Darvas’ box theory only suggests trading rising boxes and using the tops of the boxes that are violated to update stop-loss orders.
Although it is a largely technical strategy, the Darvas box theory as it was originally conceived mixed some fundamental analyzes to determine which stocks to target. Darvas believed that his method worked best when applied to industries with the greatest potential to excite investors and consumers with revolutionary products. He also preferred companies that had posted solid profits over time, especially if the market as a whole was volatile.
Darvas Box theory in practice
The Darvas box theory encourages traders to focus on growing industries, which means that investors expect to outperform the global market. During the development of the system, Darvas selected a few stocks from these industries and monitored their prices and trade daily. While monitoring these stocks, Darvas used volume as the primary indication of whether a stock was ready to take a big step.
Once Darvas noticed an unusual volume, he created a Darvas box with a narrow price range based on recent ups and downs in trading sessions. Inside the box, the bottom of the stock for the given time period represents the floor and the tops create the ceiling. When the stock has crossed the ceiling of the current box, Darvas would buy the stock and use the ceiling of the violated box as a stop-loss for the position. As more boxes were crossed, Darvas would increase trade and increase the stop-loss order. The transaction generally ended when the stop-loss order was triggered.
The origin of Darvas’ box theory
Traveling as a dancer in the 1950s, Darvas obtained copies of Wall Street newspaper and Barron’s, but only used stock prices to determine its investments. By designing boxes and following strict business rules, Darvas transformed an investment of $ 10,000 into $ 2 million over an 18-month period. His success led him to write “How I Made $ 2,000,000 in the Stock Market” in 1960, popularizing the Darvas box theory.
Today, there are variants of the Darvas box theory which focus on different periods to establish the boxes or simply integrate other technical tools which follow similar principles such as support and resistance bands. Darvas’ initial strategy was created at a time when the flow of information was much slower and when real-time mapping did not exist. Despite this, the theory is such that trades can be identified and entry and exit points defined by applying the boxes to the graph even now.
Limits of the Darvas Box theory
Critics of the Darvas box theory technique attribute Darvas’ initial success to the fact that it traded in a very bullish market and argue that its results cannot be achieved if it uses this technique in a market. bearish. It is fair to say that following the Darvas box theory will overall produce small losses when the trend does not develop as expected. The use of a stop-loss follow-up order and the monitoring of the trend / momentum as it developed has become a staple of many technical strategies developed since Darvas. As with many trading theories, the true value of Darvas’ box theory may actually be the discipline it develops among traders when it comes to controlling risk and following a plan. Darvas emphasized the importance of logging trades in his book and later dissecting what went well or not.