Strategy of Legendary Millionaire Trader Nicolas Darvas

A trader who amassed millions in less than two years

nicolas darvas legendary millionaire trader, Lightning Source Inc

Nicolas Darvas is not your typical legendary trader; he was a dancer by profession. Nicolas Darvas became interested in the stock market in 1952 when he was paid in stock for a performance. A jump in the stock price resulted in a nice profit, and he was hooked. Over the next several years he faltered before finding a trading method that worked well for him. In 1957 to 1958, over an 18 month period, Mr. Darvas made $2.45 million off a $25,000 initial stake.

In 1960 he published How I Made $2,000,000 in the Stock Market. Darvas lived from 1920 to 1977; here are some great quotes which capture his journey from market novice to legendary millionaire trader.

How to find what stocks to buy?...You must have information...I asked everybody..."Do you know a good stock?" Oddly enough, everybody did seem to know one. Whatever I was told to buy, I bought. It took me a long time to discover that this is one method that never works.

Nicolas started out where most traders start out...knowing nothing but having a sea of information/opinion around him. Learning from others is fine, but research everything you hear before acting on it. Most people lose money trading, which means most of the information you get from people will result in a loss. Don't take tips, unless it's from a profitable source that tells how to get in, how to get out (for a win or loss) and how to manage the trade.

Instead of taking tips, Nicolas went on to become a "fundamentalist." He longer took wild gambles based on random advice, but rather only bought companies with improving earnings and increasing dividends. This was another trap though.

I did not realize my method had not improved—that I was simply using more pompous words to cover it. For instance, I no longer considered the broker's advice as tips, but as "information." As far as I was concerned, I had given up listening to tips and instead was receiving authentic news based on valid economic evidence.

Darvas made the classic beginner mistake: thinking additional knowledge would make him a successful trader. Different information isn't necessarily better information. Information is not enough to become a profitable trader. You need to gain experience and learn lessons for yourself. 

Nicolas kept at it. Eventually he created his own trading system, not so much based on fundamentals which we found were fallible on their own, but rather based on price action. He looked for stocks that showed strength by reaching new highs, and staying above prior lows. This is essentially a simple trend following technique. He called it the box theory, and it provided the framework for the Darvas Box indicator (which would come much later). The approach allowed him to stay in winning stocks, and exit ones that didn't move as anticipated.

Take a stock, which was within the 45/50 box. It could bounce between those figures as often as it liked and I would still consider buying it. If, however, it fell to 44½, I eliminated it as a possibility. Why? Because anything below 45 meant it was falling back into a lower box and this was all wrong—I wanted it only if it was moving into a higher box.

Nicolas discovered that this is how prices move.

They move up, then form a new price area, then move up, then form a new price area...until they don't. Risk was controlled by placing a stop loss below each new price area that formed. If the price broke above the box he bought (Nicolas only went long, not short).

Box size is the tricky part. Nicolas didn't force a box size on the market, rather he let the market decide.

What I had to decide was the range of the box. This, of course, varied with different stocks. For instance, some stocks moved in a very small frame, perhaps not more than 10% each way. Other wide-swinging stocks moved in a frame between 15% and 20%.

Here is an example of how he created boxes, from How I Made $2,000,000 In The Stock Market.

It might have gone like this:
50 - 52 - 57 - 58 - 60 - 55 - 52 - 56
That meant it was in the 52/60 box
[a recent high and low the price bounced off of].
After this, on an upward swing, it might have gone:
58- 61 - 66 - 70 - 66 - 63 - 66
This meant it was well inside the 63/70 box. 

Later Nicolas Darvas added back in one fundamental criteria to his box theory. 

I would select stocks on their technical action in the market [the box theory], but I would only buy them when I could give improving earning power as my fundamental reason for doing so.

He would only buy stocks with rising boxes if the company was also seeing rising earnings. 

Finally, how did Nicolas Darvas get out of his trades? If the price dropped below the current box, or a future one, he sold. This allowed him to make big returns on stocks that kept trending, but risk was always limited.

When to sell then? Why, when the boxes started to go into reverse!...That was the time to close the show and sell out. My trailing stop-loss, which I moved up behind the rising price of the stock, should take care of this automatically.

The Darvas method worked well in rising markets (since he only bought) but the method wasn't profitable when the stock market as a whole was in decline because there were few buy signals. During such times the flexibility to go short would have aided Nicolas in profiting from both up and down markets.

Final Word on Nicolas Darvas and His Strategy

Darvas learned that tips didn't make him money, and fundamentals alone didn't work either. His success came from buying stocks that simply kept going higher. He waited for the price to move within a box (a high and low) and then bought at a new high. A stop loss went below the new box that formed, and was moved up to the next box as it formed, and so on. This allowed him to participate in strong trending moves while controlling risk and not giving back loads of profit when a stock reversed.

Darvas is a good example of a trader who mastered one simple strategy, instead of trying to know everything about everything.