Darvas Box Theory - Explained
What is Darvas Box Theory?
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Table of ContentsWhat is Darvas Box Theory?How Does Darvas Box Theory Work?The Darvas Box Theory in PracticeThe Origin of Darvas Box TheoryLimitations of the Darvas Box Theory
What is Darvas Box Theory?
The Darvas box theory was developed in the 1950s by a professional dancer, Nicolas Darvas. This is a trading strategy used by investors to target stocks by considering high trading volume as a key indicator of rise in the value of stocks. Investors use this strategy when prices in the market are above the previous high but not totally different from the previous high.
How Does Darvas Box Theory Work?
As developed by Nicolas darvas, the Darvas box theory entails an investor establishing the entry level and the activation of the stop-loss order in an investment. To establish this, an investor purchases stocks trading at new highs and draw a box around the recent highs and lows. Here are some things to note about the Darvas box theory;
- The Darvas box theory is not time-bound. The theory can be used at any market period.
- Investors use this theory as a strategy of targeting stocks that have a tendency of increased trade volume.
- It is often used in a rising or bullish market.
The Darvas box theory is a technical strategy used to target stocks in the market. It uses the combination of technical analysis and market momentum theory to indicate the appropriate time to enter or exit the market. Investors apply this theory as an indicator of when to enter or exit the market. This theory works when highs and lows in the market are updated over time, a line is drawn along highs and lows to make the Darvas box. According to the strategy, investors should consider trading only in rising boxes and monitor the trend or movement of the boc as a signal of when to exit the market or update a stop-loss order.
The Darvas Box Theory in Practice
In practise, the Darvas box theory is designed to help investors have performance that surpass the overall market performance. This theory is based on monitoring the growth of an industry by using the performance of selected stocks, their market prices and trading trends overtime. Monitoring a set of stocks, especially high volume stocks would help investors determine implied strong moves by stocks and when they are to enter or exit. As practised by Nicolas Darvas, he selected few stocks and monitor trends in their prices and tradings. He sees volume as a major indication of a likely move by a stock, he created a box for adequate monitoring, this also informed investment decisions made by Darvas.
The Origin of Darvas Box Theory
The origin of the Darvas Box theory can be traced back to the 1950s when it was developed by Nicolas Darvas, a professional ballroom dancer. He devised this theory by monitoring stocks and trends in prices, drawing boxes without neglecting the acceptable trading practises in the market. Using the box theory, Darvas realized a tremendous profit within 18 months and this made the Darvas box theory more popular. Through a book written by Darvas in 1960 about how he turned a $10,000 to $2,000,000 made the theory become more prominent. Investors that use the Darvas box theory to identify entry and exit points in trading.
Limitations of the Darvas Box Theory
Although, some investors rely on the Darvas Box theory to make certain investment decisions, critics argued that Darvas was only able to turn his $10,000 investment to $2,000,000 because he traded in the bullish market and not the bearish. This implies that this theory is not suitable to a bearish market, an attempt to apply this theory in a bear market is tantamount to significant loss. Also, it was argued that some trends in the stock market cannot be predicted and if the trend does not play out as planned, the Darvas box theory could cause losses for the investor.