Understanding Darvas Boxes: When it’s OK to Break the Rules

by Darrin Donnelly on October 27, 2010

Click on chart to enlarge.

Click on chart to enlarge.

There are times when common sense adjustments have to prevail over set-in-stone rules. 

While following exact Darvas Box definitions for entering and exiting stocks does give you a sound trend-following strategy, to get the most out of the Darvas System you need to sometimes give your stocks a little extra leeway.

Nicolas Darvas himself did this when conditions warranted it.

A good example of a time to make exceptions to strict Darvas Box rules can be seen in the case of current Darvas stock: WYNN.

WYNN broke out of a $95.88-$85.72 Darvas Box on October 11th.  It then, technically, formed a new Darvas Box of $104.58-$99.81.  However, as was pointed out in the Darvas Trader PRO newsletter, that box was too short and shallow to use for establishing a new support level (exit point). 

A trusted Darvas Box, (that is, a Darvas Box we can trust for establishing new support levels and therefore exit points) should be at least 7% deep, from top to bottom. 

A box that spans less than 7% is simply too shallow to use for support levels when we’re dealing with high-flying Darvas stocks.  It’s not at all uncommon for Darvas stocks to pull back 10% to even 20% rather rapidly before continuing on with their upward trends.  That is simply the nature of Darvas stocks, which are big-earning market leaders that accelerate quickly.

When assessing Darvas stocks, we also prefer to see longer boxes.  That is, as a rule of thumb, the longer it takes to form the box, the more reliable the box is. 

A Darvas Box formed in just five days isn’t nearly as reliable as a box formed over the course of five weeks.

Look at what happened to WYNN last week (note the chart that accompanies this article).  The stock fell below that technical box bottom (to a low of $97.30) and likely shook out some weak holders.  It then abruptly turned around and blasted to new highs on heavy volume.

Now, WYNN has once again, technically, created another new Darvas Box.  This one ranges from $107.36 to $101.70. 

But, just like the previous Darvas Box, this Darvas Box is too short and shallow to be used for establishing new support levels.   Its depth is less than 7% and, as of right now, the box is just five days in length.

While new highs (breaking above this Darvas Box at $107.46) would be a good spot to pyramid into an already-established position, you wouldn’t want to place stops under the current box at $101.60 for the reasons discussed above. 

Of course, the real news with WYNN is that it will report earnings after the bell on November 2nd. 

The numbers this company reports and the conference call that accompanies the announcement will likely move this stock one way or the other.  For this reason, you wouldn’t want to establish a normal-sized position if WYNN does break into new-high territory before the earnings announcement.  You should also adjust whatever position you already have in WYNN to account for the added risk involved with the earnings announcement. 

Where should your current stops be placed?  That question is answered in the current issue of Darvas Trader PRO.  The purpose of this article is to simply point out that there are certain exceptions to strict Darvas Box rules and by understanding these exceptions, you will have a lot more success with the Darvas Trading System.

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* Portions of this article appeared in the October 27, 2010 issue of Darvas Trader PRO.  You can try Darvas Trader PRO risk-free for 30 days by clicking here.

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