Before making his above-mentioned fortune, Darvas had been studying the stock market for many years. Even though he was a professional dancer, he spent a lot of his off hours reading books about trading, sometimes even up to eight hours a day. After having read around two hundred books on the subject, he came to the following conclusions:
- A true winner in a bull market is often a fastest-growing company in a fastest-growing industry. In other words, the company must be of sound fundamentals itself.
- On the share price chart, a winner often marks the beginning of its great run by reaching a new fifty-two week high. It shall ideally be accompanied by expansion in volatility and volume.
- After the breakout, the price often retraces a little and forms a tight consolidation pattern which he called a “box”. Ideally, the bottom of the box shall not overlap with the breakout level.
- The best time to buy is when the price just breaks above the box, as it confirms that the uptrend has resumed. In Darvas’ own words, he liked to “buy high, sell higher”.
Having gained such insights in the market, Darvas devised a simple trading routine which consists of three easy steps.
Firstly, he subscribed to the Wall Street Journal and Barron’s, and read them every week to search for companies with the most promising future. Remember, he was touring around the world and there was no internet, so the issues were already one week old when they reached him. However, such delays didn’t prevent Darvas from finding useful ideas, because a big move usually take weeks or even months to complete, and the difference of one week is just very short in comparison.
Having selected the best companies, Darvas monitored them closely and looked for any “box” (reliable consolidation pattern) which he could trade. Remember, he was doing this with outdated financial magazines, so the prices he obtained were not the most up-to-date. It did not hurt him too much, though, because the “boxes” that he looked for usually took a number of weeks to form before a breakout could happen.
After identifying a tradable “box” on the chart of a sound company, he would contact his broker to place a buy-stop order. A buy-stop order is a buying order which is effective only after the price reached above a certain level. Suppose Darvas found that the share price of a stock was forming a “box” between $46 and $52, and he only wanted to buy it if it went above $52, then he could place a buy-stop order above $52, say at $52¼.
Together with a buy-stop order, he would also put in a stop-loss order. In this case, a stop-loss order is a protective order which closes out the position if the price does not act well and falls below a pre-determine level. Darvas often placed a stop-loss order just below the lower end of the “box” so that it could get him out of the position automatically when he was not watching the market. The use of stop-loss orders was a very important ingredient in Darvas’ success, because it is not just about how much he made when he was right, but also how much he did not make when he was wrong. The strict discipline of adhering to a stop-loss policy is the hallmark of a successful trader, and most aspiring traders are unable to do it.
And if a position showed him a profit, Darvas would not be in a hurry of taking it immediately. He fully understood that great profits take a long time to develop. If the share price went up in his favour, and if the underlying company was a true winner, then it would inevitably form a secondary “box” somewhere above the preceding one. When it happened, Darvas often moved up his stop-loss order to a level just below the secondary “box” to protect his existing profit. More importantly, if the price did well and broke above the secondary “box”, he would increase his position at the new breakout level with another buy-stop order. In this way, Darvas would be able to make the most out of a great run with minimal risk.
In more technical terms, Darvas’ trading plan is actually a trend-following system, which refrains from activity in a dull and rangebound market, and only takes action when a great market trend is in place. It sounds so simple that almost everyone could understand it immediately, but putting it into practice is extremely difficult. It is not due to a limit in intelligence, but a lack of discipline and patience. Most people come to the stock market for quick riches, and for this reason they are not mentally prepared for the repetitive routine of research, and the long period of doing nothing when there is nothing to do. And even if they are, most of them are unable to handle the fact that they could only be right for less than fifty percent of the time. Their frustration often makes them quit before that truly winning trade arrives.
In conclusion, it only takes a simple strategy to do very well in the stock market. Darvas is also one of the very first people which promote a “techno-fundamentalist” approach to the market: using both technical and fundamental analysis in making decisions. There are many other classics after his book, but they have very few new ideas to add to Darvas’ philosophy. I wholeheartedly recommend the book to everyone who wants to make a killing in the stock market, especially the novices.
Reference: Darvas, N. (1960). How I Made Two Million Dollars in the Stock Market. Secaucus, NJ: Lyle Stuart.
No comments:
Post a Comment