Darvas Box Trading Lesson 3
Darvas in Practice
Your First Darvas Scan
Scanning for Darvas boxes is simple. Select “Scan for DarvasBoxes” from the Scanning menu.
You will be presented with the Darvas scan dialogue box.
Clicking “Scan” will start the scanner and in a a few seconds the result are available in the “Search Results” box.
Darvas Box Construction
A Darvas Box represents a graphical trading plan. Our buy orderis placed on a break of the box top with our initial stop-loss set at the price at the box bottom. The height of the box represents our risk level per share (excluding brokerage).
Let me clear up some points of confusion about Darvas boxes. I must admit that when I first read his book, I assumed that Darvas was looking for 3 points of resistance, and then for some support level.
This interpretation is incorrect. The sequence for correct Darvas Box construction is as follows:
- There must be some volume activity in the stock, i.e. a volume spike of a specified level before the first box forms.
- The stock must be in an upward trend on entering the first box.
- The top of the box is found when a price is reached that is an x-day high price (e.g. 200-day high) and then this price is not touched or exceeded for a specified number of days (Darvas usually used 3 days). This point is important. Darvas was not looking for 3 days of resistance, he was looking for a confirmed top of the trading range.
- After a box top is confirmed, the bottom is found in the same manner but in reverse. i.e., once a low has formed and not been exceeded for 3 days, this becomes the bottom of the box.
- When the top and bottom are confirmed we have a box. Now we may calculate an initial stop-loss level based on the price at the bottom of the box.
Another source of confusion regarding box construction is where the top and the bottom of the box form on the same day.
This is actually referred to in Darvas’ book. It’s in the section at the back taking the form of a Q and A session. This, in my opinion, is the part of the book containing the most relevant information on box construction (the main text of the book is a bit vague on this).
It is valid for the top and bottom to form on the same day. Darvas considered this to be quite rare, but our analysis shows that on the contrary it’s quite common. In Darvas’ defence, he didn’t have the luxury of scanning software.
Choosing Your Stocks
Something to consider when trading using Darvas boxes is your choice of stocks. Darvas did not trade cheap stocks, his adage was “buy dear, sell dearer”. He was trading stocks priced at over $30 per share in the 1950s; he was not interested in cheap, speculative stocks.
Another characteristic of Darvas’ trading was his attention to the price movement behaviour of stocks; this was how he came to develop the box theory.
His research led him to look for stocks with a specific signature to their price movement patterns. His preference was for stocks that made strong definite movements through the box top. Stocks making new price highs incorporating some slight retracements, and then possibly leading to the creation of a new box.
The following figure is an example of such a stock pattern.
Darvas’ preference was for stocks in what were then newly emerging hi-tech industries such as Hewlett-Packard, or for companies with innovative product development such as filter tipped cigarettes. Remember, this was the mid-1950s!
Do Your Homework
Darvas’ box technique gives us a ready-made trading plan.
However, this is only part of the planning process. There are other factors to consider before we enter the trade. Many trades are unsuccessful for the reason that no thought is given to the simple task of calculating a breakeven level for the trade. The breakeven level is the price that must be reached by the stock so that a stop-loss placed at this level will result in a no loss trade. Any price achieved beyond this point must result in a profit for this trade if we exit at this price.