Darvas Box Method 📈🗳️ Legendary Trading System Explained

In its simplest form, the Darvas System looks for stocks that are trading in a relatively narrow price range for an extended period of time. This signifies that supply and demand are in balance, with buyers and sellers content to trade shares back and forth within the established boundaries. However, at some point one group will gain the upper hand and push the price outside of the consolidation box.

Darvas believed that once a stock moved decisively past the high or low of the recent trading range, it signaled underlying strength or weakness that would cause the move to self-perpetuate. His approach was to let the market confirm the breakout by closing above or below the consolidation region before initiating a position in the anticipated direction of the move.

In addition to breakouts, Darvas also looked for stocks with above-average trading volume. He knew that significant participation by both individual and institutional investors lent credibility to the price action. Analyzing volume helped validate whether a breakout truly represented a major shift in supply and demand.

Risk management was central to Darvas' strategy. Positions were held only as long as the stock kept setting new highs or lows each day. If the price failed to surpass the prior day's extreme, Darvas would sell to lock in profits. He also never risked more than 2% of his total portfolio on a single trade to minimize downside.

An analyst scans the market and notices that shares of Company A have been trading between $40-45 per share for the past month. This sideways movement indicates balancing supply and demand.

After a few weeks, Company A reports strong earnings that exceed expectations. In response, the stock price jumps above $45 and closes above this level, confirming the breakout.

Having identified the $40-45 consolidation range and seen a closure above $45, the analyst initiates a long position in Company A at the current market price of $46.

Over the next few days, Company A continues rising as the positive earnings news causes buying momentum. Since the stock is making higher highs each session, the analyst holds the position.

On the fifth day, Company A trades down to $48 intraday but fails to close above the previous day's high of $49.

Following Darvas' rule of selling if no new high is made, the analyst sells Company A at $48 to lock in the 2-point profit per share. The total gain amounts to around 5% for the trade based on portfolio allocation.

This example illustrates how Darvas' approach could play out in practice - from range identification, to breakout confirmation, trade initiation, monitoring and predefined exit rules. The focus is on riding short-term momentum fueled by catalytic events.

By consistently applying his method over several years in the 1950s, Darvas was able to grow his account into the millions. His success was outlined in the famous book "How I Made $2,000,000 in the Stock Market." Even today, many traders find the "Darvas Box" approach intuitive for timing entries in momentum trades.