Learn the Darvas Box Trading Strategy

05/24/2011 7:00 am EST

Focus: STRATEGIES

This simple method based on price and volume has been trusted for well over a generation and lives on today as one of the neatest, most efficient indicators for daytrading E-mini futures contracts.

It’s not often that a ballroom dancer becomes a famous investing author and in the end develops a trading system that has lasted more than 50 years, but this is the case with Nicolas Darvas.

It would be an understatement to say that the Darvas Box remains popular and effective in the current investment world. Many of today’s finest investors and investment educators espouse the Darvas Box method is one of the most effective methodologies for trading E-mini contracts.

Darvas originally only traded the Darvas Box method for long trades, but today his methodology has been refined for both short and long trading. Further, Darvas used his methodology for long-term trading, usually a year or more.

Adapting his series to short-term trading, especially daytrading the E-mini contracts, has not lessened the effectiveness of his original investing thesis; which is to say that the ideas he developed in the early 1950’s are effective when trading intraday E-mini contracts in present times.

On a side note, it is often claimed that Darvas was able to invest $36,000 into $2 million over a three-year period. That claim alone makes this somewhat obscure trading methodology worthy of study.

There was a time when it was essential to hand draw the boxes on daily investment graphs, but the world of computers has changed all that; most investing platforms include the Darvas Box as one of the indicators that an investor can include on his or her chart.

What Is a Darvas Box?

This methodology combines aspects of technical trading and fundamental trading. As much as anything, Darvas was interested in volume and price in his assessment of potential profitable stocks in which to invest.

The boxes that are formed through observed highs and lows and a specified trading cycle identified the methodology as a trend following system, though I much prefer classifying the Darvas system as a momentum system, as this definition more clearly defines the exact methodology, in a definitional context, than a simple trend following system.

Darvas himself identified a series of “states” in a normal stock growth trend, and identifying and exploiting those “states” is better suited for an entire book rather than a short article. Darvas identified highs, lows, and consolidating patterns on a stock chart and integrated the highs and lows to form a square box.

Typically, these boxes can be observed to be rising or falling in accordance with the current movement of the equity under study. Each box serves an important purpose, as the bottom portion of the box (in a long trade) or top portion of the box space (in a short trade) form specific stop-loss targets traders can utilize to minimize their losses and maximize their gains.

Most modern daytraders use Darvas Boxes, as they are formed in a manner that is very similar to support and resistance theory. A close with confirmation above or below the top of an existing box can indicate a breakout or breakdown, and hence, the potential for a profitable trade.

I especially like the Darvas Box method because I am quite partial to breakout and breakdown trades, as they are often among the most powerful and profitable trades available to intraday investors. Darvas Boxes provide an excellent methodology to identify breakouts and breakdowns in trending markets. Conversely, Darvas boxes are also very effective at identifying consolidating markets where breakouts and breakdowns often form and then fail.

One of my favorite trades is to fade a failed breakout or breakdown as it returns to the original channel, or centerline of a Darvas Box.

NEXT: How to Trade the Darvas Box Method

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To fully understand Nicolas Darvas and his trading methodology, I highly recommend further study before trying to implement it into your trading. There is little doubt that this trading method has great merit and is used by many influential investors.

While I would not discount oscillators and indicators as important parts of an E-mini trader’s arsenal, all the important action in my trading occurs on the chart graph. Price action is everything, and the patterns of support and resistance formed by price action are the basis for my E-mini trading.

That is not to say that I am not interested in oscillators and indicators, only that I use these tools to confirm my potential set-ups gleaned from the price chart. Although often overlooked, the venerable Darvas Box is also one of the neatest and most efficient indicators in my trading.

I wasn’t always interested in the Darvas Box, and I have to give credit to a well-known trader named Hubert Senters for initiating me into the finer points of this trading method. As time has gone by, I have learned to rely upon this diminutive indicator for a variety of purposes.

At its very simplest explanation, one need only observe the rising or falling of successive boxes to get an instant and in-depth view of where and how the market is moving. When each box is formed, an upper boundary of that particular price movement is formed, and vice versa for the lower boundary of the box.

On the upside, a great long trade may be indicated when the price closes above the upper boundary of a given Darvas Box. I often use several charts side-by-side on my screen, and it is not coincidental that the upper and lower boundaries of Darvas Boxes coincide with existing support and resistance.

However, the success of climbing or descending of the block structure gives me a unique viewpoint on both price action and support and resistance. In short, the Darvas Box is both a E-mini chart object and an indicator. Better yet, it sits directly in the price action section of my charts so I can make quick and immediate decisions on potential set-ups.

How to Trade the Darvas Box

I trade the Darvas Box very similarly to support and resistance and ignore price action as it bounces around inside the box as a consolidation period. In a trending market, the market takes frequent pauses to consolidate before continuing back in the direction of the trend.

Of course, this is not to say that every Darvas Box breakout will be successful. Like all systems, there are false breakouts and a distinct probability of failure in every set-up. For that reason, I prefer to use the Darvas Box only in trending E-mini markets.

I should note that Darvas himself only intended his methodology to be used in the stock market and its adaptation into the E-mini market is a distinct extension of his methodology. Of course, any E-mini trade you may consider that does not entail a breakout or breakdown in the box is likely to fail. However, there can be little doubt that regardless of the time frame, the methodology holds great merit.

So why not just use support and resistance and not the Darvas Box?

In my trading, the Darvas Box gives me both support and resistance information along with market directionality. This means I can glance at a chart and ascertain a wealth of information that would take several minutes to understand on a traditional candlestick chart.

As any futures trader knows, there are times when quick decisions are required, and nothing in my trading system can match the Darvas Box for quantifying those decisions. Further, I often change time frames when using the Darvas method to get a different look at price movement and consolidation patterns in a trend.

Normally, these patterns can be very difficult to pick out of a bar or candlestick chart, but the Darvas method handles these duties with ease.

These breakouts and breakdowns are potential set-ups for E-mini trades and should be evaluated as such. In short, Nicholas Darvas developed a wonderful system to see the market at a glance and make solid and sound trading decisions.

By David Adams of The E-mini Trading Professor

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