A number of years ago I stumbled upon the classic stock market book, “How I Made $2 Million In The Stock Market” written by Nicolas Darvas. If you’ve never read this book, I highly recommend.
Nicolas Darvas was a professional dancer who essentially turned a $50,000 account into $2 million over the period of a couple years during a huge bull market in the late 1950’s.
After repeated failure, he developed a somewhat systematic approach to identifying very hot stocks and a method for entering and exiting positions in these stocks. However, Darvas also took on a huge amount of risk, which is what allowed him to accumulate his wealth so quickly.
Darvas developed what he described as his “box” theory. He essentially looked for stocks that were trading in a clear uptrend, but would occasionally consolidate within a narrow trading range.
Once the stock broke out of the range, he would buy, and he kept a very tight stop loss.
This first buy would be a test buy, and if the stock continued higher, he would pile in with a sizable position.
This is the opposite of “pyramiding” where you would buy most of your position first, and then add more in smaller increments.
Darvas did not have charts to view as we do today. Instead, he reviewed stock prices in a weekly issue of Barron’s magazine while he was traveling around the world.
If he noticed a stock rising in price, he would then start to pay closer attention. If the stock started jumping in price and this was accompanied by an unusual volume increase, he would look for an opportunity to buy.
Initial Trades by Nicolas Darvas with his Darvas “Box” Method
This chart shows Darvas’ campaign in Lorillard stock. He first began asking for stock quotes at point A when he identified that the stock was in an uptrend and that trading volume had increased dramatically. His initial purchase in this stock was at $27 ½, and he placed a sell stop at $26.
He was stopped out at $26, and then he bought back in at $28 ¾ (stocks were quoted at 1/8 point back then and up until the advent of electronic trading).
These initial purchases involved 200 shares. Darvas then noted that Lorillard traded higher and into a range from $31 to $35. He bought a total of 400 more shares at $35 and $36.50.
The stock then rose to as high as over $44, and then dropped suddenly to a low of $36 ¾ and closed at $37 ¾.
He raised his stop loss to $36 and then the stock moved higher. He bought 400 more shares at $38 5/8. He now had a total position of 1,000 shares at prices from $28 ¾ to $38 5/8. Darvas ultimately cashed out of this stock in May 1958 at an average price of $57 3/8.
His total profit was over $21,000. His primary reason for exiting the stock was because he noticed another stock, E.L. Bruce was really jumping.
He began buying E.L. Bruce and he accumulated 2,500 shares in chunks of 500 shares each at prices from $50 ¾ to $53 3/8.
These purchases were based on E.L. Bruce climbing from $18 to $50 without a reaction. Furthermore, the volume in the shares traded was rising significantly.
It then pulled back to about $43, and Darvas had it in his mind to buy if it broke above $50.
After he accumulated his entire position, trading in the shares was suspended. He ultimately sold out this stock at an average price of $171 per share for a profit of over $295,000.
After starting with about $50,000 in Fall of 1957, Darvas had now traded his account to over $300,000 by July 1958 with three big winners.
While Darvas had a particular method for identifying and entering positions in rising stocks, he did not define his stop loss strategy precisely, nor does he define his exit strategy in great detail.
Proponents of the Darvas method generally place stops below the lows of the trading range from which a stock breaks out.
Once a position is entered, and the stock becomes profitable, the trailing stop rises with the bottom of each ensuing box.
Trading Lessons Learned From The Darvas Experience
My primary takeaway from the Darvas book was that stocks that are ready to really jump significantly will provide you with a couple significant clues beforehand.
First, the stock will experience a significant rise in price within a relatively short period of time from a few days to a few months.
Second, at some point during this rise, there will be a spike in the volume of shares traded.
Resolute is a great modern example of what to look for. In July 2016 there was a significant rise in the price of the stock accompanied by a sharp increase in volume.
Most of what I see today from traders who suggest that they are following the Darvas strategy is that they are only looking at price. Incredibly, there is virtually no mention of Resolute by traders who purportedly employ this type of strategy when the stock was beginning to move.
Many stocks will rise in the step ladder manner that Darvas explains in his book, with one “box” forming above another. However, the price rise in most of these stocks tends to be slow and choppy. The reason is that big institutional investors who can really move the stock are not plunging in.
To catch the types of moves that Darvas did to generate such large profits in a short period of time, you need the volume component in place as well. Volume is the fuel that will drive a stock’s price into the stratosphere.
The final lesson that I think is important for many new traders to understand is that Darvas cut his losses quickly and was willing to re-enter at a higher price.
Catching the momentum of the trade at the right time is crucial, and there is no sense holding a position that is going nowhere or declining. Preservation of capital is key if you want to exploit big moves.
What I would NOT recommend is Darvas’ method for adding to a position. A quick reversal at the wrong time would generate much bigger losses, which can shake the confidence of any trader.
As such, the position should be built piecemeal, with each new buy being smaller than the last.
And there you have it…the Darvas method was the final piece in the puzzle for me in the development of my core stock trading strategy.
The CANSLIM method opened my eyes to focusing on stocks making new 52 week highs, and paying attention to general market conditions.
The Turtle Trading System (including discretionary criteria that I did not discuss in that article) turned my attention to risk management and studying market behavior.
The Darvas method then completed the puzzle for me by providing the clues to look for in a stock that is ready to charge higher in the foreseeable future.
When you combine all of these elements, you are left with a formidable strategy for building wealth in the stock market. Therefore, I highly recommend continued research into these methodologies to any individual seeking to build an income stream from stock market speculation.
I highly recommend the books below as part of your research.