Darvas Box Trading Strategy – Trading Secrets From A Dancer?

Posted in: Advanced Trading Strategies, Trading Article

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Learning a trading strategy from a dancer may sound crazy but if it is the Darvas Box trading strategy made famous by Nicolas Darvas , it would not be so crazy after all.

It is reported that Darvas , using his box method while travelling the world dancing, turned $36000 into over $2 million in 18 months trading the stock market.

How did this dancer, while dancing on stages around the world, manage to amass such a fortune?

As the name implies, Nicolas Darvas used boxes drawn around price and would trade the breakouts of the boxes in the direction of the trend.  That is a high level view as there is more to it, but in a nutshell, that was the technique he used.

Here is what the American Research Council had to say about Darvas and his trading success story:

As a result, the COUNCIL now takes pride in presenting one of the most extraordinary success stories in the history of Wall Street. It is especially significant not only because this investment record was made by a true nonprofessional and “outsider” who was investing for that legendary “second income”, but also because the profits he made were not the result of a lucky killing or chance tip.  On the contrary, the investment methods that eventually made Mr. Darvas a millionaire were the result of hard-won experience, years of mistakes and learning from those mistakes. These specific, highly practical methods can serve as a useful guide to every individual investor.

At Netpicks, we believe in a systematic way of approaching the markets and the Darvis Box method may be something of interest to those new to the world of systematic trading.

 

How The Darvas Box Trading Strategy Began

The foundation for the Box strategy started when  Darvas , using only price action and volume, started buying stock in a company called M&M Woodworking.  What he didn’t know was that the increase in price was happening because of merger rumors that were circulating.

It didn’t matter.  The price action and volume was all he was using to buy the stock.  In the end, he sold out 2 point before the high and before the merger was announced.

He simply bought an upward moving stock using his Box theory- trading with the trend of the stock (trend following).

Latching on to his last success, Darvas bought into another fast moving stock that was climbing in price.  This time, it turned out that simply buying something that was moving up wasn’t a great play and he lost $2000.

It was a loss that that concerned him for a few reasons:

  • It was the best performing stock at the time
  • Price reversed back to the upside soon after he took the loss (we know that feeling)
  • Turns out, he bought the top of the stock

Darvas dove into hundreds of stock charts and learned about the movement of price in each stock.  In doing so, patterns began to emerge.

He found that stocks once in motion, tend to stay in motion and do so in a series of frames.

Darvas Box Trading
Darvas Box Trading

Seems simple, right?  It’s not much different than the resistance level breakouts that some traders use today.  But just like today, trading breakouts without some type of volatility measure usually does not end very well.

As well, you want to see some type of increasing activity before the breakout and not just buy on the expectations of a breakout.

Darvas bought an aviation stock thinking it was about to break the high of one box and lead into another.  He bought, the stock turned around, and wiped out the profits from the previous three trades ($2400).

From these experiences, Darvis laid out some objectives in approaching the markets.  That is not much different than Netpicks reminding traders to have a trading plan before you enter the market with any trading strategy.

  1. Right stocks
  2. Right timing
  3. Small losses
  4. Big Winners

To achieve these goals, Darvas wrote out what he would use to achieve this plan he had:

  1. Price and volume
  2. His Darvas Box theory
  3. Automatic buy stop orders – orders to enter the market above current price
  4. Automatic stop loss orders – order to exit the trade below current price

 

Darvis Box Trading Strategy

We covered a lot of information about the box theory and in essences, the trading strategy for the Darvis Box looks like this:

  1. Trade breakouts from the box in the direction of the trend
  2. Trail his stop loss which will protect his open profit as price trends higher
  3. Buy more as the trend continued to move upwards
  4. Take his profits or cut his losses when the trend reversed

This does not include the stock selection process or what type of volatility measure to use to give the you the odds that the breakout has the potential to succeed.

Most often in the stock market, volume would be used but you will have to determine the type of volume you need to see.  You may want to test such things as an increase in volume that exceeds the a 20 period average of the previous days volume.

3 Day High Low Darvas Box
3 Day High Low Darvas Box
  1. When a stock fails to make a new high for three days, the most recent high that is higher than the three subsequent highs becomes the box top.
  2. When a stock fails to make new lows after three days, the most recent low that is lower than the three subsequent lows becomes the box bottom. (We are using the low after the high is formed)

Once the bottom breaks in an uptrend, the stock would be taken off the list until a new box forms.

A break of the top would indicate a trading opportunity.

Here is a recent example of the stock Johnson and Johnson

Darvas Box Trading Example
Darvas Box Trading Example
  1. This box is well formed but price dips to the downside and a gap up and over the top of the box (you will need to rule base what to do with gaps)
  2. A new box forms and the green arrow points to the breakout of the stock above the box.
  3. Trade is held for 24 days and ends with a break below the box +2.53% gain or $125.38 profit per share

Losing Darvas Box Trade

Losing Trade
Losing Trade
  1. Using a buy stop order at the break of the box, the trade is entered
  2. While in the current trade, a new box forms following the 3 day high/low rule – still in trade
  3. Price breaks the box lows and exit at next candlestick open – 2.72% loss or $135 per share

Please keep in mind that the breakouts shown were not backed up by a volume study.  The results could be different if there was a measurement made of the strength of the breakout.

 

Darvas Box Trades Setting Up

I thought it would be interesting to take a look at a few stocks where the Darvas Box strategy was starting to set up.

TPIV
TPIV

 

ICPT
ICPT

 

Darvas Box Strategy – Breakouts From Consolidation

If you are reading this and thinking this is a breakout strategy, you’d be correct.  The difference between the Darvas Box and the way the majority trade breakouts, is there are rules in regards to how the box forms.

Darvas would look for highs in price and whether that was 52 week highs, 100 day highs or all time highs, it doesn’t really say in his book. He would also scan for stocks that were primed for growth which back in his day could have been a wide variety of stocks.

Darvas would also consider volume to assist in determining if a breakout could be sustained.

Can this be a valid approach in other markets or without the added criteria of volume and instrument selection?

There is no question that this is a trend following trading strategy that will get chopped up in consolidated environments (perhaps using a 3 day buffer was Darvas was of avoiding that).  Breakout trading is a good strategy when combined with other criteria and the ability to cut losses when the breakouts fail.

This is a rudimentary back test of stocks of S&P 100 that spans 6744 bars of data.  Looks promising and this is without stock selection, volume measures or tested stops, profit taking or entries that could perform better without over-optimizing the back test.

Darvas Box Trading Strategy Equity Curve
Darvas Box Trading Strategy Equity Curve

In the end, it is up for every trader to test any trading strategy that they are interested in.  The Darvas Box trading strategy goes back decades but the key idea is that it is a strategy complete with trading rules including where and when to enter.

When we design our trading systems, we make certain that:

  • Every system was tested historically on both sample data and out of sample data
  • We wanted to make it easy on traders so everything related to the trade – stops, profit targets, entries, trailing stops, are all plotted right on the chart – no guesswork
  • Complete training on every aspect of the system so every trader knows exactly what to do and when.

There are unanswered questions with the Darvas strategy – including which highs to use – and you will have to determine what the best measure of increased strength is to allow for a higher probability breakout trade.

Breaking a trading strategy down is a good learning tool for developing traders.  In the end, it may be too much work (plus you need to learn how to properly test it WITHOUT over-optimizing) and if you find that to be the case, reach out to support@netpicks.com.  

Let us help you get on the right track to the trading goals you have.

 

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CoachShane

Trader at Netpicks
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.

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