Nicolas Darvas was a famous dancer, self-taught investor and author, who instead of trusting company fundamentals like price-to-earnings ratios and dividends, preferred to pay attention to public sentiments, a philosophy that worked best in volatile markets.
“In my dancing, I know how to judge an audience. It is instinctive. It’s the same with the stock market. You have to find out what the public wants and go along with it. You can’t fight the tape, or the public,” he said in his book How I Made $2,000,000 in the Stock Market.
Due to his professional dancing commitments, Darvas had to do trading from wherever he performed, so he ignored tips, financial stories and brokers’ letters and never went to a broker’s office for trading.
“I have no ego in the stock market. If I make a mistake, I admit it immediately and get out fast. I never bought a stock at the low or sold one at the high in my life. I am satisfied to be along for most of the ride,” he said.
How it all started
Before relocating to the US in 1951, Darvas studied economics at the University of Budapest after which he trained with his half-sister, Julia, to be a ballroom dancer, He achieved a lot of success in his dancing career and went on several world tours.
Darvas discovered investing in 1952, when a Toronto nightclub, unable to pay him in cash, instead paid him with shares.
Darvas’ book , How I Made 2,000,000 in the Stock Market, is an investment classic that can be found on many recommended reading lists, as it is still widely read and very popular. The book explains Darvas’ own transformation from a simple investor into a smart craftsman.
A lot of traders identify easily with Darvas because he went through the same learning process of trading like many other amateur investors.
When Darvas started trading, he invested on the basis of stock tips and experts and made the mistake of selling in panic and buying every other stock in the news.
“It took me years to realise that when these financial tipsters advise the small operator to buy a stock, those professionals who had bought the stock much earlier on inside information are selling,“ he said.
Having suffered major losses early in his investing career, Darvas realised he must educate himself if he were to have a successful foray in the stock market.
How Darvas amassed a fortune in investing
When Darvas started investing, the first thing he wanted to learn was the secret to success in the stock market. But he realised that he couldn’t achieve success from trading on the basis of stock tips of others, including brokers and expensive newsletters.
Darvas figured out that he had to develop a trading strategy on his own in order to achieve success. He had no mentor to turn to, but he never let the lack of knowledge become an obstacle and started reading financial publications and reports even during his trips.
So he put in a lot of hard work and perseverance and conducted years of study of the market and built an excellent investment model which came to be known as the ‘Darvas Box’.
He developed the ‘Darvas Box’ strategy when he was on a two-year world tour. That method is simply a way of screening stocks based on stock price and volume.
Darvas is said to have read more than 200 of the best books on the market by great investment experts before building this unique approach, which helped him make $2,450,000 in just 18 months.
The Darvas Box Theory
Darvas Box Theory is a trading strategy that targets stock highs and volume as key indicators.
The trading technique involves buying stocks that are trading at new highs and drawing a box around the recent highs and lows to establish an entry point and placement of the stop-loss order.
A stock is considered to be in a Darvas Box when the price rises above the previous high but falls back to a price not far from that high.
It is a type of momentum strategy, as it uses market momentum along with technical analysis to determine when to enter and exit the market.
How to create Darvas Box
A Darvas Box is a simple indicator created by drawing a line along lows and highs of a stock. As the highs and lows of the stock are updated over time, rising boxes or falling boxes can be seen.
The Darvas Box Theory suggests only to trade in stocks making rising boxes pattern and using the highs of the boxes that are breached to update the stop loss.
Darvas believed his method worked best when applied to industries with the greatest potential and revolutionary products. He also preferred to use companies that had shown strong earnings over time.
Darvas also shared some tips in his book that can help investors find success in the investment industry.
Let’s look at some of them.
Shortlist potential trading candidates
Investors should filter the potential trading candidates using certain rules in order to be profitable in the market. Darvas felt investors should look for industries that are expected to do well in the next 20 years.
He believed investors should research the market history and find the instruments with the greatest growth potential. “The leading industries are always changing and you must have a keen eye for the next big thing in order to make the right choice,” he said.
Keep an eye on trading volumes
According to Darvas, investors should keep a close watch on the trading volumes of the selected stocks and wait for an unusually high trading volume in any of them.
He felt this will help monitor the price behaviour. He believed investors could look at three-day low levels and three-day high levels of price fluctuations.
“The combination of price and increased volume is key to stock selection. Focus your time on new leaders emerging with a new market cycle,” he said.
Develop your own trading philosophy
Investors should come up with their own trading philosophy. “We cannot stress strongly enough how important it is to rely on your own skills and not to blindly trust any market advice. One of the quickest ways to lose money in the market is to listen to others and all of their so-called expert opinions. To succeed, you must ignore all outside opinions and predictions. Follow your own strategy,” he said.
Keep your ego aside
Investors shouldn’t try to out-power the market because investors will almost certainly fail to do so. “A willingness to admit a mistake is fundamental for a successful trader. Simply accept that you are wrong and move on instead of insisting on a losing trade,” he said.
Darvas believed investors should not allow themselves to hold on to a loser or sell a winner. He felt the key to achieve this was to forget about their ego the moment they start trading in the financial markets.
“You should expect to be wrong half of the time. Your goal is to lose as little as possible when you are. Losses are tuition on Wall Street. Learn from them,” he said.
Recognize Market Trends
It is important for investors to recognize market trends and stick to them because most financial instruments follow general market trends.
“There are no good or bad stocks; there are only instruments on the rise and instruments that are in decline. Therefore, it is very important to recognize market trends and stick to them because most financial instruments will follow general market trends. Of course, there are always exceptions but they only confirm this basic rule. The same applies to stocks in different industries as the majority of instruments in a group tend to follow the leader,” he said.
Stay Focused
There are three main factors that can make investors fail in the market:
- The desperation to trade after a loss
- Overconfidence
- Failing to follow a predefined plan
Darvas felt when investors make each one of these mistakes it is a clear sign that they have lost focus and have to regain it.
“The easiest way to do it is by taking note of the reasons that make you trade and try to find the thought patterns that contribute to a loss. Then try to retrain your emotions and see the results,” he said.
(Disclaimer: This article is based on Nicolas Darvas’ book “How I Made $2,000,000 in the Stock Market”.)
