Darvas Box Trading Strategy Explained

Darvas Box is a great technical analysis indicator, with an interesting background and creator. Nicholas Darvas, a dancer by trade, made $2,000,000 in an 18-month period trading stocks using the Darvas Box method, while traveling the world on dance tours. The method is designed to capture emerging trends, and ride them for big potential profit, all while keeping risk contained.

What Is the Darvas Box?

The Darvas Box strategy was developed by Nicholas Darvas. Aside from being a well known dancer, he began trading stock in the 1950s. Based on his success in trading, he was approached to write a book on his strategy. The book, “How I Made $2,000,000 in the Stock Market,” outlines his rather simple approach … simple once you understand the basic concepts and rationale of the strategy.

Darvas originally started with $10,000. He was willing to plunk the whole amount into one stock. This is because he always used a stop loss to control risk, so the whole amount of capital was not fully in jeopardy. As his capital grew, he would allocate capital to various stocks.

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Darvas Box Strategy

As the name implies, Darvas Box is based on boxes that a price was trading in. For example, if the price is moving between $45 and $50, that is a box. Mr. Darvas’s goal was to only buy stocks that were moving into higher and higher boxes.

If the price moved above $50, to $50.50, Mr. Darvas bought the stock because it was now moving into a higher box. If the price dropped below $45 (of the $45 to $50 box), to $44.50, then the stock was moving down a box, and therefore was negated as a purchase candidate.

The box limit is not set, but is determined by market forces. If the price is moving between $47 and $48, that creates a box. If it moves higher, the next box may be between $50 and $53, which is the next point where the price stalls and moves back and forth.

A price can stay in a box for as long as it wants. As long as it doesn’t drop below the low of the box, it remains a buy candidate if it moves above the upper limit of the box.

Mr. Darvas gives the following example in his book, of a stock breaking higher into a new box:

If the stock acted right, it started to push from its 45/50 box into another, upper box. Then its movement began to read something like this: 48 – 52 – 50 – 55 – 51 – 50 – 53 – 52.

It has now quite clearly establishing itself in its next box—the 50/55 box.

Darvas Box is an indicator that simply draws lines along highs and lows, and then adjusts them as new highs and lows form. The indicator is available on many trading platforms, such as Thinkorswim. Traders may wish to draw their own boxes though, based on recent highs and lows; Darvas was able to do so (based on telegram quotes) more than half a century ago.

Darvas Box Rules

Darvas established some rules, not just for his strategy, but for himself. After going though his initial learning period of subscribing to a whole bunch of “advisory services,” he found that none of them worked, and they often contradicted each other. Therefore, he proposed seven basic rules to impose on himself.

The following are summarized from his book.

  1. I shall not follow advisory services.
  2. I shall be cautious of broker advice.
  3. I shall ignore Wall Street sayings or truisms, no matter how ancient or revered.
  4. I shall only trade stocks on major exchanges with adequate volume.
  5. I shall not listen to (or trade off of) rumors or tips, no matter how well researched they may sound.
  6. I will use a sound strategy instead of gamble…I must study this strategy (originally this approach was fundamental analysis, which didn’t work for him, so he developed his Darvas Box trading method).
  7. I will hold one position for longer, as opposed to juggling a bunch of positions for a short period of time.

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These rules helped Nicholas Darvas develop his strategy, and have the discipline to stick to it. The basic Darvas Box strategy rules are as follows:

  • Darvas looked for increasing volume when selecting stocks to trade; this alerted him to stocks that were being accumulated and were likely to see strong trends.
  • Darvas believed in buying stocks that presented an upper box limit breakout, but also had an upward Earnings trend. This was especially the case when the major indexes had experienced a decline.
  • When an upper box limit is broken, buy. From his book, the entry price was usually about 1 to 2% above the upper box limit.
  • If you enter a trade and the price proceeds to drop out of the new box, and back into the old box, exit the trade.
  • Entry and stop loss orders should be set in advance, so trades aren’t missed and risk is controlled.
  • Place, and trail the stop loss order to below the low of the most recent box. This initial stop loss was pretty tight, because Darvas assumed when a price broke out of an old box, it was entering a new box. Therefore, the stop was placed just below the high of old box which was just broken (low of new box).
  • Record trades, including reasons why you entered and exited.
  • General conditions of the market must favor buying. Don’t buy stocks when the major indexes are in a bear market, or when volume is flat or declining.
  • If you are stopped out, but the price moves back into the higher box again providing another buy signal, buy again, using the same stop loss location.
  • Since the stop is being trailed up, more funds can be added on each consecutive breakout.

Figure 1 shows Darvas Box in action.

Darvas Box Applied to AAPL Daily Chart
Figure 1. Darvas Box Applied to AAPL Daily Chart – Source: Thinkorswim

Risks and Considerations

During choppy market conditions the strategy is likely to produce many small losses in a row. This is a trend following method, so a trend needs to develop to produce a profit.

Based on his book, the initial stop loss was set just below the breakout price (likely low of the new box). It was then trailed up as new boxes formed. This method takes a lot of discipline, and a trader can’t get emotionally attached to a stock. Buy and sell when the signals say so.

Traders also need the intestinal fortitude to get back into a trade, if the signals say so, even if they were stopped out. Darvas also added to positions as breakouts to higher boxes occurred. This means bigger gains on trades that work out, but if the trend doesn’t continue, adding to positions near (what ends up being) the top of a move can work against you.

The method could also be employed using short selling when the boxes are dropping. An entry occurs when the price moves below the lower limit of the box; a stop is placed just above the entry price (in the old box) and then trailed down above the top of new lower boxes.

A stop loss won’t save you from losing more than expected if the price gaps through your order. Consider this when assessing how much capital you are willing to commit to a stock.

See also Which Position Sizing Strategy is for You? Equal Risk vs. Equal Dollar

The Bottom Line

Nicholas Darvas was a dancer, but committed a great deal of time to developing and then mastering his stock trading method. It’s a trend following method based on breakouts to higher boxes. Risk is controlled by placing a stop below new higher boxes as they form. During choppy conditions the strategy won’t be profitable. This is why Darvas also attempted to only trade stocks with increasing volume and rising Earnings. Trading his method requires a lot of discipline, but can produce big profits when strong trends develop.

Cory Mitchell