#TradingUniversity Darvas Box Theory:
How Nicholas Darvas Build Wealth. Simple in a easy way but with Sticking to his rules and working Smartly.
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 contact 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.