Darvas box trading: A 21st century blueprint

While a 52-week price high produces more trades than the all-time price high, it is less likely to run into any overhead resistance. When a stock’s price declines, it will form a steady series of lower price highs followed by lower price lows. It’s at these price points that investors are buying because of a belief that the stock is undervalued. If the stock continues to decline, then these investors face a difficult choice: Sell or hold. Often, they choose to hang on hoping to break even, and it’s at these price points where overhead resistance is formed. If the stock trades back to these price levels, then these investors start selling. This can derail the stock’s trend or stall it by making price action trade sideways (see “Overhead resistance,” below).

Using the all-time price high offers fewer trades, but without any overhead resistance to cause this kind of problem.

The other gap in Darvas’ method is that technical indicators weren’t available during his time. This wasn’t his fault, but nevertheless is potentially a powerful enhancement of his approach. What if Darvas had the ability to identify the right amount of volume to time his entries? Or what if he could have used moving averages to filter mediocre trades from winning trades with greater volume?

With today’s tools, perhaps Darvas could have achieved even greater results.

Filling in the gaps

A modified approach is proposed. The new Darvas box trading 2.0 method combines what worked in the past with today’s tools to help refine the setup conditions and the trigger for the trade.

This Darvas box trading 2.0 setup is  long-only as detailed below:

  1. Use the 20-day and 50-day simple moving averages (SMAs) on the daily chart.
  2. Price is trading within 10% of an all-time high and above the 20-day and 50-day SMAs.
  3. Price stays within this 10% range for a minimum of three weeks.
  4. Support and resistance are established, forming a rectangle or box-like price pattern.
  5. Trade up through resistance on greater than 30-day average volume.
  6. Price closes above the previous price high.
  7. Enter on the opening of the following trading day.

Adding the SMAs acts as a filter to keep you in stocks that are trending higher and out of stocks whose price action is weak. Also, your entries are better timed by having a specific level of volume at the time of your entry to establish the quality of the breakout to the upside (see “Box entry,” below).

Trade management

Darvas focused greatly on price action during his trading days, but he also focused on finding potential stock candidates where the market was showing the greatest strength. He had coined the term “techno-fundamentalist,” meaning that while he looked for strong fundamentals in a stock, he based his decisions on whether to buy or sell on technicals.
In risk management, you always want to manage your position so you risk as little capital as possible. Darvas’ method called for moving your stop just below any new higher low established in a stock’s price action to trail the stop-loss point with a potential for capturing a runaway move. However, a good rule of thumb is to take profits at three times your initial risk and move your stop to break even on the other half. This style of trade management makes you some money in the short-term, while putting you in a position to win big at the same time.

There are times when you will see another Darvas box 2.0 setup occur after you enter a position. You can do one of two things: Adjust your stop just underneath the pattern’s support level to control risk, or you can pyramid and add to your position.

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About the Author

Billy Williams is a 20-year veteran trader and publisher of www.StockOptionSystem.com, where you can read his commentary and a report on the fundamental keys for the aspiring trader.