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What is Darvas Box Theory? Examples and Practical Application

Last updated 03/19/2024 by

Abi Bus

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Darvas box theory is a trading strategy developed by Nicolas Darvas that uses highs and volume as key indicators. This article explores the theory’s principles, how it’s practiced, its origin, and its limitations.

What is darvas box theory?

Darvas box theory, created by Nicolas Darvas, is a trading strategy that focuses on stocks’ highs and volume as crucial indicators. This technique involves buying stocks trading at new highs and drawing a box around recent highs and lows. By doing this, traders establish entry points and stop-loss orders. A stock is considered to be in a Darvas box when its price rises above the previous high but falls back to a price not far from that high.

What does darvas box theory tell you?

Darvas box theory is a momentum strategy that combines market momentum theory with technical analysis to determine entry and exit points in the market. It involves drawing lines along the lows and highs of stock prices, creating rising or falling boxes as a result. Traders are advised to trade only rising boxes and update their stop-loss orders using the highs of the breached boxes.
Although primarily a technical strategy, the original Darvas box theory included elements of fundamental analysis. Darvas preferred targeting stocks in industries with high potential for innovative products and companies with a history of strong earnings, especially in volatile market conditions.

The darvas box theory in practice

The Darvas box theory advocates focusing on growth industries expected to outperform the overall market. Darvas, the creator of this system, selected stocks from these industries and monitored their prices and trading daily. When he observed unusual trading volume, he established a Darvas box with a narrow price range based on recent highs and lows.
Within the box, the stock’s low represents the floor for that time period, and the highs act as the ceiling. Buying occurs when a stock breaks through the box’s ceiling, using that level as the stop-loss. As more boxes are breached, Darvas increased the trade position and adjusted the stop-loss accordingly. The trade typically concludes when the stop-loss is triggered.
Nicolas Darvas developed this theory in the 1950s while traveling the world as a professional ballroom dancer.

The origin of darvas box theory

Nicolas Darvas, who fled Hungary before the Nazis in the 1930s, became a professional dancer after reuniting with his sister following World War II. In the late 1950s, he and his sister were among the highest-paid dance duos globally, touring to sold-out crowds.
While on tour, Darvas obtained copies of financial publications like The Wall Street Journal and Barron’s. He used the listed stock prices to inform his investment decisions. By applying his Darvas box theory and adhering to strict trading rules, he turned a $10,000 investment into $2 million in just 18 months. This remarkable success led to his book “How I made $2,000,000 in the stock market” in 1960, popularizing the Darvas box theory.
Today, variations of the Darvas box theory exist, with adjustments made to time periods for establishing boxes or integrating other technical tools, such as support and resistance bands. While Darvas’ original strategy was developed in a time with slower information flow and no real-time charting, it remains applicable today.

Limitations of the darvas box theory

Critics of the Darvas box theory attribute Darvas’ initial success to a highly bullish market. They argue that achieving similar results in a bear market using this technique is challenging. It’s worth noting that following the Darvas box theory can lead to small losses when market trends don’t align with expectations.
Many technical strategies have since incorporated trailing stop-loss orders and the momentum-following approach that Darvas emphasized. The true value of the Darvas box theory may lie in the discipline it instills in traders in terms of risk management and adherence to a plan. Darvas stressed the importance of keeping trade logs, enabling traders to analyze what went right and wrong in their strategies.
Here is a list of the benefits and drawbacks to consider.
  • Darvas Box Theory helps identify stocks with increasing trade volume.
  • This strategy is adaptable, not limited to specific time periods.
  • It works best in a rising market or when targeting bullish sectors.
  • By focusing on growth industries, it allows for potential outperformance.
  • The strategy encourages discipline and systematic risk management.
  • Darvas Box Theory may underperform in bearish market conditions.
  • It requires traders to be vigilant about stock movements, which can be time-consuming.
  • Results can vary based on individual trader knowledge and experience.
  • Adhering to the strategy’s rules may result in missed trading opportunities.

Frequently asked questions

Is Darvas box theory suitable for all market conditions?

No, Darvas box theory is most effective in a rising market or when targeting bullish sectors. It may not perform well in bearish market conditions.

What are the primary indicators used in darvas box theory?

The key indicators in Darvas box theory are stock highs and trade volume. Traders draw boxes around these highs and lows to make trading decisions.

Are there variations of darvas box theory in use today?

Yes, contemporary traders have adapted and modified the original Darvas Box Theory to suit modern market conditions. Some variations adjust the time periods for establishing boxes, while others integrate additional technical tools like support and resistance bands.

What should traders consider when selecting stocks to apply the darvas box theory?

Traders should consider targeting stocks in industries with high potential for innovative products and companies with a history of strong earnings, especially when the overall market is volatile. This aligns with Nicolas Darvas’s approach when he initially developed the strategy.

Key takeaways

  • Darvas box theory is a momentum strategy targeting stocks with increasing trade volume.
  • It works best in a rising market or when focusing on bullish sectors.
  • The strategy involves drawing boxes around recent highs and lows and trading when stocks breach the box.
  • Nicolas Darvas popularized this theory in the 1950s, achieving significant success as a trader and dancer.
  • The Darvas box theory may develop discipline in traders but can result in small losses when market conditions are not favorable.

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