The Nicolas Darvas box method chart pattern is a pattern that I found very useful to spot stocks that are likely to move higher or lower. In his book, How I Made $2 Million In The Stock Market, Darvas pointed out that he uses boxes or consolidation to help him spot big winners in the stock market. Personally, I have found it very useful to use boxes and consolidations to gauge whether the stock is likely to move higher or not. After I have learnt about Darvas' method I modified it a bit and used it to analyze stocks.
It is very easy to spot the Darvas Box chart pattern. The stock will consolidate and trade sideways and the trader can draw a box over the the price congestion. Once price breaks above the box, the stock is considered to have broken out higher. The sideways consolidation should be relatively tight compared to the normal price action in the stock.
It is important to remember that the trader should not simply draw a box on any price congestion. The sideways trading should be relatively tight and stay within a tight range.
When the stock is trading within the box, we can consider that the bulls and bears are in a battle during that period. While the stock is in the box, we do not really know which party will win. If price breaks above the box, we can consider that the bulls have won. If price breaks below the box, we can consider that the bears have won the battle.
The Darvas box can be used to:
I have found that the Darvas box pattern is very useful and the trader who knows how to utilize this chart pattern can draw immense benefit from this chart pattern. I will provide the explanation of each of the usage below and hope that you will be able to make use of this box pattern to increase your technical analysis skills.
One of the reasons why we study charts is to know who is in control. There is always a struggle between market participants. On one side are the bulls and on the other side are the bears. When a trader looks at a chart, he or she will be able to see who is in control.
The appearance of the Darvas box chart pattern can help the trader gauge the power of the bulls and the strength of the bears.
In the chart above, we can see that MCHP is in an uptrend. This showed that the bulls were in control of the stock. But how do we know that this stock has more bullish strength than bearish power? You can see in March 2017 that the stock had a big red bar. For most stocks, the appearance of a big bearish bar after a nice run up will usually be followed by more correction.
Despite the appearance of the big bearish bar, the stock merely drifted sideways and formed a box. This told us that the strength of the bulls was much much stronger than the strength of the bears. The bears lack the power even to make this stock have a meaningful correction.
If the bears had some strength, they would have pushed the stock lower. A total lack of meaningful correction and the appearance of sideways trading shows that the bulls strength is much superior. So when a trader sees this pattern, he or she can be more confident in holding the stock. Some might even buy more of the stock when it breaks above the box.
What works on the bullish side also works on the bearish side in the Darvas Box analysis. In the chart above, MAT was already in a downtrend. This told us that the bears were in control. There were many gap downs in this stock but it formed 2 consolidation boxes.
Normally, when a stock is in a downtrend, there can be bear rallies which shows that the bulls have some power. The very fact that MAT did not even have a meaningful rally after the 2 gap down shows us that the strength of the bears were much more superior than the bulls. It was as if a big heavy weight is being put on the shoulders of the bulls and they could not even lift an inch of the weight off their shoulders.
So, the summary for this section is this:
The stock market is all about the struggle between bulls and bears. I call them battles.
Everyday there is a battle between the bulls and bears and if the market goes up, it means the bulls won the day. If the market closes down, it means that the bears won the day. I would say that the war has already been won by the bulls since the Dow Jones Industrial Average and the S&P 500 index has been going up in the long run for the past 100 years. You would need the Dow and S&P to go back to the levels in the 1950s before we can consider the bears having won the war.
The way that the S&P 500 Index is structured makes the bulls the winner in the grand scheme of things. That's a story for another day. But even if the stock market is geared to bullishness in the long term there are always corrections and bear markets that can last for years.
Here is the basic principle on how to determine who is the winner:
Simple as that.
When a Darvas Box pattern is forming, we do not really know in which direction that the stock will break out into. But the probabilities usually favor the preceding trend:
This is following the principle of "the trend is your friend" and "a trend in motions tends to stay in motion". So, the odds usually favor the direction of the preceding trend.
When you are using boxes to determine who won the battle, in my opinion, you do not need to have the stock form the perfect Darvas box pattern. Just a simple box will do. You can allow the stock not to have the tight perfect consolidation.
In the chart above, AABA gave us 3 examples of how the bulls emerge as the winners of a battle. It may take some practice for a new trader to learn how to draw a box. Generally try to find a nice consolidation sideways trading area and then draw a box around it.
You can see how in the first 2 boxes, the stock broke above the box decisively and then went higher. Since the stock is in an uptrend, the odds favor an upside breakout. The bulls also won the 3rd box but it has decline a little into the box since then. Nevertheless, the bulls are still the winner in the last battle. If the stock drops below the current box then those who are holding this stock would really need to evaluate if something significant has changed in this stock. They will need to see if they should still hold on to this stock.
CERN is another example where knowledge of Darvas Boxes will give the trader confidence in holding on to this stock. From February to June, the stock was able to win every single battle. This is a good sign and very encouraging for those who are holding this stock.
In July, the bears won the battle and thus the correction and selling in the stock. However, the victory for the bears was short lived because the stock formed another box and this time the bulls won the battle. Another box is forming and we still do not know who will win the battle.
The chart of DISCA above shows the bears winning a battle. The previous move in DISCA was down, therefore, the odds favor the bears when the box formed. After the bears won the battle, the stock continued to drop lower. Once again, those who know about the Darvas Box and how to use it to analyze stocks will be able to take advantage of this knowledge and get out earlier. Some may even want to short this stock.
One of the areas of support are congestion areas. In fact, the heavier the congestion area is, the stronger the support is. Since the Darvas Box pattern is a congestion area they are actually support areas too. Thus if we can draw boxes, we will be able to draw very clear support areas that are easy to see. Learning to recognize support areas are very important to the trader because it helps the trader know if he or she can hold on to the stock longer or be more cautious.
The weekly chart of the S&P 500 index above shows several box areas which I have drawn. They are congestion areas and they will act as strong support in the future if S&P 500 drops. Big congestion areas in the weekly chart which you can draw a box are often very good support areas in the future. Thus, if there is a correction occurs in the future, these areas will be the area to watch for a rebound.
You can also use boxes to search for support areas in the 60 min chart. SPY had a congestion area in late August which I have drawn a box. The SPY rallied and then it dropped to support and formed a bottoming tail and rallied from there. Boxes are great areas to find rebounds in the general indexes.
Actually, you can use boxes in any time frame to find support areas. Whether it is weekly charts, daily charts, 60 min charts, 15 min charts and even 5 min charts. The chart above is the daily chart of GILD. The stock made a box around July 2017. The stock rallied but then corrected. GILD found support at the box area and continued to rise from there.
Now that you know the many usages of the Darvas Box, you have enough knowledge to know how to utilize this chart pattern for initiating trades. There are 4 ways you can use it for trade signals:
With regards to breakout signals and support trade areas, let's take the example of GILD again. Traders can buy the breakout above the box and set a stop loss below the box. It is always good to have the previous move to be upwards. Remember the saying a trend in motion stays in motion? Therefore, if you plan to buy a box breakout, it is always good to see if the previous move before the box forms is a move up or not.
Since the box area is also a support area, if the stock rallies and corrects, the trader can try to find trades when the stock drops to the support area. Notice how GILD had a correction and drop to the box area? Traders could have bought the correction to the support area and see the stock rally from there.
Traders can also use the Darvas Box as short trades. Traders can short the stock when it breaks below the box and put a stop above the highs of the box. To increase the odds of success, it is best to see if the previous move before the box forms is down or not. A stock that is in a downtrend has a better chance of success.
Traders should always remember to choose nice tight box patterns if they want to buy the breakouts or short the breakdowns. Do not simply draw any box and trade it. You should choose tight consolidations that signal a period of rest and not wide whippy movements that you can draw a big box around it. That is reading a chart pattern into a stock price and not being objective.
In the chart above, NGVC was in a downtrend as it is below its 200 MA, 50 MA and 20 MA. When it broke below a box, the trader can short the stock and put a stop at the top of the box. Since the box area is also a resistance area, traders can also look to short the rallies that go into the resistance area.
Always remember that the box is a resistance area and not a definite price. It does not mean price will stop at the low of the box and reverse. Sometimes the stock might rally into the middle of the box and then decline. NGVC rallied back into the area of the box, meet the declining 20 MA and broke a trendline. Traders could short the stock when it broke below the trendline.
Congratulations on learning about the Nicolas Darvas Box Method. Although we modified it a bit to use it for different functions, the box method has proved to be very reliable and accurate in helping traders to navigate the markets. Personally, I find it to be very useful. Especially as a support resistance tool and to see who has won the battle. Hope that this knowledge will help to increase your analytical skills in technical analysis and trading the stock market.
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