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Nicolas Darvas and the stocks that double

Posted on 3/08/2012
The market is having a pullback after a up leg that started in December. During the move around 100 stocks have doubled from their 52 week low. Some of these stocks will setup for further up move during the correction phase.

Nicolas Darvas popularized a very simple trading method in his book " How I made $200000 in stock market" to trade such stocks. Darvas was interested only in stocks that doubled from 52 week low. His logic was they are proven horses. The logic also makes sense based on empirical research . Empirical research shows that stocks with momentum (3 to 1 year out performers) tend to go up in next 3 to 1 year.

Nicolas Darvas would further reduce the universe of stocks that doubled by looking at stocks that have made all time high. That reduces the universe of around 100 stocks that doubled from 52 week low by half to around 30 to 40 stocks.

The next criteria Darvas used to reduce the universe was sector. He was interested in what he called "infant industry". His logic was a stock making all time high in a static or dying industry was not worth his time and effort as it is unlikely to make a big subsequent move. He was interested in a young sector with potential for substantial growth. If you use that criteria on the 30 to 40 stocks you would be left with 10 or so candidates to focus on.

On those 10 stocks Darvas used further criteria to narrow the list. He was interested in only stocks with best earnings growth or stocks with great earnings expectation in future. That would further reduce the universe of stocks that he was interested in to 4 to 6 stocks. On those stocks he would look for capitalization and float and prefer smaller stocks. He would also look for volume during the doubling of price and was interested in stocks that had substantial volume surge during their up move.

Nicolas Darvas was basically playing a probability stacking game. Each of his criteria increased the probability of finding a big mover. Combined all those probabilities and you have a very high probability stock with potential to make big move.

Once he identified a stock like that he would wait for it to form what he called a "Darvas box". Darvas Box was nothing but a sideways consolidation of few days to weeks or months on such stocks. He would buy the stock when it broke out of that consolidation on high volume. He would use a limit buy order to enter above the consolidation. Once in the stocks he put his stops near the box high. His logic was that if the high volume breakout out of the box indicates start of new up leg then the stock should not go back in to box.. If that happened it was a mistake to buy the stock. He was willing to get stopped out several times with small loss.

Once the stock started going up he would put his stop near the new box low and keep raising it as the stock moved from one consolidation area to another. He would also keep pyramiding in to stock along its up move. He aggressively used margin. At some stage the stock would reverse and take out the box low and he would be stopped out of his open position.

Dravas called his method "Darvas Method in Rising Market". He traded it only in bull market. He sat out bear markets. Darvas method is a momentum+fundamental based stock selection method. It is a good method for working people or people who can not watch market in real time.

Darvas method can easily be setup in trading software like Telechart. All that you need to do is setup a scan that looks for stocks that have doubled from 52 week low and that are within 15% of 52 week high. Once you get the list, you can manually eliminate stocks that are not near all time high. After you have the list you can use free sites like MSN money, or Yahoo Finance, or Finviz to research the stock further and create 4 to 5 stocks prospect list.

Nicolas Darvas Criteria List:

  1. Double from 52 week low
  2. All time high
  3. Infant sector
  4. Current earnings growth or expected growth
  5. Low capitalization
  6. High volume surge
  7. Box or range near recent high

Nicolas Darvas summarized his  momentum based approach very nicely :

My only reason for buying a stock is that it is rising in price. If that is happening, no other reason is required. If that is not happening, no other reason is worth. 

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MRSTOCK said...

And it should now be quite easy with all the computer power and analysis software around, to do some analysis on whether this system actually works ! Does it? My gut feeling is no.

AbsoluteSpeculation said...

MrStock, you don't have much knowledge of trading theory and the way that the market is structured if you believe that it doesn't work. This style of speculation has always existed in markets and it will always work, as long as humans participate.

It's okay to be skeptical, but once you do your own due diligence, you too will discover that most successful speculators in markets use similar concepts.