Darvas box is a classic trading system created by Nicolas Darvas. Nicolas was a professional dancer and was introduced to the world of stock market when one of his performances was paid in the form of stocks. After a few weeks, the stock’s value rose, and this fascinated Nicolas. He had made a good return in a few weeks of time.

In today’s newsletter, we will understand how Nicolas created his famous trading system and the logic he used. We will first look at the concept of a ‘Box’, then know some of the rules of Darvas trading system. In the next newsletter, we will understand the rules in depth and look at some of the examples.

Understanding the ‘Box’

After Nicolas booked the profits from his first trade, he became interested in learning about the stock market. At first, he could not figure out the price movements of a stock. He could only look at the charts and see that the price either moved up or down. Because he was a professional dancer, he used some of his dance analogies to make sense of the stock market.

During one of his chart readings, he observed that the chart can be divided into boxes. He observed that the price does not move randomly but rather in a trend and within this big trend, there exists smaller trends. He observed that in these smaller trends, the price moved consistently within a fixed frame or, as he liked to call them, “Boxes”. The price would oscillate between a low point and a high point of the box. The high point of the box was called a ceiling, and the low point of the box was called a floor.

Darvas observed that these boxes were clearly stacked on top of each other. In this way, ceiling of one box would become the floor of the next higher box. When the price would break a ceiling, it would enter the next higher box and when the price would break the floor, it would enter the previous lower box. Just like a dancer who wants to jump higher takes a recoil downward, a price would also trade within the box before moving up.

The range of the box was not fixed. It could be anything. At first, Nicolas struggled to mark the boxes. But eventually, he discovered an objective way to mark the boxes. In simple words, the ceilings and floors were nothing but support and resistance levels. The boxes and marking methods only made it objective to mark these levels.

The Rules of Darvas box

This trading method was first introduced by Nicolas Darvas in his 1960 book, How I Made $2,000,000 in the Stock Market.

In his book, Nicolas provides general guidelines about the box, but with few objective rules for stock selection when applying the system. At the time, the concept of a rule-based approach to trading was still quite new. While it was not fully possible then, we can now establish clear rules for this system. The Darvas Box rules revolve around:

1. The breakout

2. Marking the ceiling

3. Marking the floor

4. Entry criteria

5. Exit criteria

6. Trailing stop loss

In the next newsletter, we will dive deeper into each of these rules and explore stocks that meet the criteria for this trading system. Stay tuned!