Previously we understood the logic of the ‘Box’ in Darvas box trading system. The box is a crucial part of this trading system. Just in case you missed the newsletter, checkout the following link. This system, when combined with the science of right stock selection, can be an effective trading system for someone who cannot be in front of the screen all the time.

You see, Nicolas Darvas was a professional dancer. he used to go around the world on his dance tours. It was only at the end of the day that he could check the price of the stocks he was interested in. He would only use the open, high, low, and close price at the end of the day that he would be faxed by his broker from New York. Based on this, he would mark the boxes and then trade the stocks. The system was such that the trader would not need to spend a significant amount of time to analyze.

Today we explore the rules of this system, the stock selection and look at some of the examples.

The Rules: Easy and Objective

The rules of Darvas box are based on:

1. The breakout

2. Marking the ceiling

3. Marking the floor

4. Entry criteria

5. Exit criteria

6. Trailing stop loss

One untold rule is that the charts used are Daily time frame Candlestick chart. This is because Nicolas got his price on a daily basis and the price points he got was open, high, low, and close. Let us try and understand each of these rules:

The Breakout Candle: In his book, Nicolas Darvas emphasized focusing on stocks nearing their 52-week high. Since his criteria were based on the daily timeframe, we consider a stock breaking its 250-day high, which corresponds to the 52-week high. The candle that breaks this level is known as the breakout candle.

Marking the Ceiling: The first candle after the breakout, whose high remains unbroken for at least 3 days, is marked as the ceiling. This could either be the breakout candle itself or any subsequent candle following it.

Marking the Floor: After marking the ceiling, we then wait for the floor to form. Similar to the ceiling, the candle whose low is protected for at least 3 days is marked as the floor.

Entry Criteria: We enter the trade when the price breaches the ceiling. It is important to note that the price simply crossing the ceiling high is sufficient; it does not need to close above it.

Trailing Stop Loss: After entering the trade, we track the formation of subsequent boxes. The floor of these new boxes becomes the trailing stop loss.

Exit Criteria: We exit the trade when the initial or trailing stop loss is breached.

The Darvas Box trading system allows us to capture the trend's full potential, while exiting at the first indication of a reversal.

Choosing the right stock

In the book, the guidelines for selecting stocks for this system were broad and somewhat unclear. Darvas favored high-growth stocks that were fundamentally strong and aligned with the overall market trend. Additionally, the stock should come from a sector that was outperforming. Volume also needed to confirm the breakout. To make these rules more objective, we’ve made a few modifications:

1. The company’s net profit should be higher than the previous year.

2. The stock should be trading above its 200-day EMA.

3. The stock should belong to a sector that is outperforming the Nifty 50.

4. Volume during the breakout should be higher than the last 50-period average.

These revised conditions help make stock selection more precise.

In summary, identify stocks that meet the above criteria, spot the 250-day breakout, mark the ceiling, establish the floor, wait for an entry signal, and trail the stop loss once you’re in the trade

A few examples

Observe the chart below of AUROPHARMA. The stock gave a 250-day breakout on 30th May 2023 around 640/- levels. It rose and formed a ceiling around 760/- levels and subsequently gave an entry. The volume confirmed during the breakout and the company was seeing a growth in its Net profit. Around the same time, Nifty Pharma started to outperform Nifty 50. After the entry was taken, the price rose till 1500/- levels in 2024.

The chart below is of BSE limited. The price broke its 250-day consolidation in July 2023 around 750/- levels. The price was also above its 200-day EMA and the volume confirmed as well. Subsequently, the price formed a ceiling around 950/- levels and gave an entry. After the trade was taken, the price rose up to 4500/- levels. Although, the price could have given a stop loss exit between these levels.

The Darvas Box is an effective trading system when paired with the right stock selection. Incorporating conditions like fundamental growth and sector outperformance increases the probability of success. By modifying these conditions to make the system more objective, stock selection becomes simpler and rule-based.

In all the courses offered under the TNT One membership, my goal is to teach how to transform a trading strategy into a clear, rule-based system. This membership grants access to all current courses and any future courses I create. Be sure to check it out! 👇🏻👇🏻👇🏻