*An Introduction to Darvas Boxes* Before we get into this explanation of "Darvas Boxes," we want to reiterate that the single biggest mistake Darvas followers make is relying too much on these technical Darvas Boxes and disregarding the main components of the Darvas System. While the Darvas Boxes are easily the most talked-about aspect of the Darvas System, you will not succeed without understanding the entire system. Having said all that, it *IS* vitally important when implementing the Darvas System that you understand the concept of Darvas Boxes.
After a stock first met all the Darvas System fundamental requirements, Nicolas Darvas would then apply his technical "Box Theory." He found that stock price movements were not erratic and random, but rather, "a series of price ranges." Darvas Boxes were simply Darvas' method of identifying these price ranges. Darvas wanted to identify key points of support and resistance in the price range of a stock. The top of the box would identify the stock's resistance level - the price point at which, at least temporarily, there are no more buyers to be found. The bottom of the box would identify the stock's support level - the price point at which there are no more sellers to be found. Darvas was looking for stocks that developed these definable price ranges - areas of support and resistance. And, he wanted to see these price ranges going higher and higher - in other words, he wanted to see higher highs and higher lows. Based on these boxes, Darvas would buy a stock as it propelled up through a box top and he would often sell a stock if it dropped below a box bottom. In other words, he would buy a stock if it broke through previous resistance levels and sell a stock if it fell through previous support levels. For example, if a stock was spending days or weeks moving up and down between 30 and 35, he'd define the Darvas Box as a 30-35 box. The top of the box, 35, would be the resistance level where the price stopped moving up. The bottom of the box, 30, would be the support level, where the stock stopped moving down. If the stock then moved above 35, it was time to consider it for purchase. Darvas would then wait to see where the new price range was established. If the stock moved up and down between 38 and 42 for several days or week, the stock was now in a 38-42 box and would be held as long as it stayed in this price range. If it broke out above 42, the stock would be establishing a new, higher box and may be considered for an additional buy. If the stock fell below 38, the stock should be sold. The following chart is an example of ICE in November and December of 2006. We've identified the support and resistance levels to make it clear. As you can see, these levels aren't all that difficult to establish: Now, there has been plenty of debate about how exactly Darvas identified the top and bottom of his boxes. In his writings, Darvas' most specific answer came in the revised 1971 edition of *How I Made $2,000,000 in the Stock Market*. In a Q&A segment new for the revised edition, Darvas explains his box tops and bottoms as follows: "The top of the box is established when the stock does not touch or penetrate a previously set new high for three consecutive days. This is true - in reverse - for the bottom of the box." In analyzing these comments, we understand that the box top takes a minimum of at least four days of stock movement to be identified. For example, on Day 1, a stock hits a high of $61, Day 2's high is $59, Day 3's high is $60 and Day 4's high is $60.50. At this point, we can see that the previously set high of $61 was not touched or penetrated for three consecutive days. Thus, the top of the box is $61. While there is some debate about whether the top of the box could be established in just three days (that is, including the day the high is made as one of the three consecutive days required for the top to be established), Darvas makes it pretty clear in the above statement that the high had to be set previous to the three consecutive days. Let's take a look at a real example of traditional "Darvas Boxes" in action. In the following six-month chart of ISRG in 2005, we see that seven traditional Darvas Boxes were formed. The Darvas Boxes are shaded blue. Darvas would normally base his buy and sell signals on how the stock price moved in accordance with these boxes. In the ISRG example, Darvas might have bought as the stock gapped out of Box B. By strictly following the traditional Darvas Boxes and their corresponding rules, one would have held the stock until the stock price fell below the bottom of Box E because the bottom of each box served as the stop-loss. As you can see, the Darvas System would have resulted in a substantial profit in roughly three months holding time. While these traditional box rules are extremely helpful and they can be very profitable, it's important to understand that they should *NOT* be relied on fully for your technical buy and sell signals, especially in today's more volatile market. After all, Darvas himself acknowledged that while these boxes were a good basic strategy, he didn't strictly adhere to the Box Theory. He sometimes decided to let his stocks fall below the box bottom without selling or he'd sell a stock while it stood in the middle of a box. He made exceptions to his strict Box Theory based on the particular price action of the stock he was holding. As you can see in the above example, there is a long stretch between Box B and Box C with no boxes being formed. This could be a real problem for many traders who would have preferred to identify new support levels for a sell point. Also, why did Darvas decide to make four days the minimum for establishing a box? Why not five or six or just two? The fact is, in some market environments, using six or seven days would be much more profitable in establishing boxes. In other environments, the two or three day rule is much more appropriate. These specifics can be argued endlessly, but what is most important is to understand the *PURPOSE* of the Box Theory: identifying support and resistance levels. Darvas' rules for establishing the Darvas Boxes made sure that he would be much less likely to sell a stock that was still moving up. For instance, most novice traders have a tendency to sell a stock too quickly because they "don't want to be too greedy." Darvas himself ran into this problem and realized that he would often sell a stock for a small profit, only to watch the stock go on to establish huge gains that he missed out on. By defining support and resistance levels, he helped make sure that the stock itself would tell him if it was running out of momentum and breaking the trend. Darvas knew he couldn't *PREDICT* whether or not the stock was done moving up and ready to retreat, so he relied on his technical analysis to tell him what to do. Of course, even using the rules Darvas created, you will often sell a stock only to watch it go on to make further gains, but these rules drastically cut down on the number of instances you will see this occur. *A NOTE ON SELL STOPS* Knowing when to sell is perhaps the most difficult skill to master in trading and selling a stock if it ever falls below a previous support level is the best sell rule to follow. But, as with all stop-loss rules in the Darvas System, you must remain flexible. Remember that Darvas himself didn't always wait for a support level to be violated before he sold. He sometimes sold positions when he saw a better looking stock breaking out, when he felt a stock was slowing down its upward movement within a box, or if the stock simply began to act very strange. Some traders prefer to sell a stock if it drops below a certain moving average, such as the 50-day or 10-day, depending on how long you prefer to hold a stock. Some immediately trade following a "climax top" which occurs when a stock that has been advancing for several months suddenly advances more in a single day than it has in any other single day during the previous months of its advance. Others simply use a percentage-based trailing stop, for instance, selling if the stock ever drops 5-10% from its high. These are sound methods also, particularly if one is getting a little more nervous about a stock's price moves and wants to lock in profit. (Make sure to review our selling rules often.) But aside from the many selling rules you should be aware of, identifying previous points of support (either at the bottom of a Darvas Box or at the bottom of another reliable pattern such as a Rounded Base) is your *BEST*option for setting new sell-stops. The most important thing to remember on stops is this: once you've made your decision to sell at a certain point, whether the bottom of a base, a moving average line, or a percentage-based trailing stop, make sure you stick to this stop and get out when your stock hits the stop. Don't over-think and over-analyze it while you hope it turns around and goes higher. It's hard to sell a stock, but having the discipline to stick to your sell rules is what separates the rich traders from the poor traders.
