Momentum Trading with Darvas Box Breakouts
The Black Book of Day Trading Strategies
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For traders looking for a simple yet effective trend-following strategy, the Darvas Box method offers a time-tested approach to momentum trading. Developed by Nicolas Darvas in the 1950s, this unique charting technique is designed to identify and trade stocks in strong uptrends. This article will provide a detailed methodology for trading Darvas Box breakouts, using the Accumulation/Distribution Line for confirmation.
Constructing and Interpreting Darvas Boxes
A Darvas Box is a consolidation pattern that forms after a stock has made a strong upward move. The box is defined by a series of new highs that are not surpassed for at least three consecutive days. The top of the box is the highest high in this series, and the bottom of the box is the lowest low during the same period. The stock is considered to be in a Darvas Box as long as it trades within this range.
A breakout occurs when the stock closes above the top of the box on high volume. This indicates that the consolidation period is over and that the stock is ready to resume its uptrend.
To confirm the breakout and ensure that it is being driven by institutional buying, we will use the Accumulation/Distribution Line. This indicator uses volume to measure the degree to which a security is being accumulated or distributed. A rising Accumulation/Distribution Line indicates that the stock is being accumulated, which is a bullish sign. For our long entry, we will require the Accumulation/Distribution Line to be in an uptrend, confirming the buying pressure.
A Framework for Darvas Box Breakout Trading
This is a classic trend-following strategy that requires patience and discipline. The following rules provide a clear framework for execution.
Entry Criteria (Long Trade)
- Identify the Darvas Box: The stock must form a clear Darvas Box after a strong upward move.
- The Breakout: The stock must close decisively above the top of the box.
- Volume Confirmation: The breakout must occur on significantly higher than average volume.
- Accumulation/Distribution Line Confirmation: At the time of the breakout, the Accumulation/Distribution Line must be in an uptrend.
Stop-Loss Placement
Once a long trade is entered, place a stop-loss order just below the bottom of the Darvas Box. This is a logical place for a stop, as a break back below the box would invalidate the breakout.
Profit Target
The initial profit target should be set at a 2:1 reward-to-risk ratio. For example, if your entry is at $55 and your stop-loss is at $50, your risk per share is $5. The profit target would then be $65 ($55 + (2 * $5)).*
Example Trade: EFG Corporation
Let's walk through a hypothetical trade on EFG Corporation.
| Metric | Value |
|---|---|
| Asset | EFG Corp. |
| Entry Price | $80.00 |
| Stop-Loss | $75.00 |
| Risk per Share | $5.00 |
| Profit Target | $90.00 |
| Reward/Risk | 2:1 |
| A/D Line | Uptrend |
In this scenario, EFG had a strong rally from $60 to $78. It then consolidated for two weeks, forming a clear Darvas Box between $75 and $79. A strong daily candle then closed at $80.00, breaking out above the top of the box on high volume. The Accumulation/Distribution Line was in a clear uptrend, confirming the buying pressure.
The stop-loss was placed at $75.00, just below the bottom of the box. With a risk of $5.00 per share, the profit target was set at $90.00. The stock moved steadily higher over the next few weeks, reaching the profit target for a successful trade.
The Psychology of Darvas Box Trading
The Darvas Box method is as much about psychology as it is about technical analysis. It requires the patience to wait for the right setup and the discipline to act decisively when the breakout occurs. It also requires the courage to buy stocks at new highs, which can be psychologically difficult for many traders.
However, the logic behind the strategy is sound. A stock that is making new highs is in a strong uptrend, and it is likely to continue to move higher. The Darvas Box provides a clear and objective way to identify these opportunities and to manage the risk.
By combining the classic charting techniques of the Darvas Box with the volume confirmation of the Accumulation/Distribution Line, traders can develop a effective and effective strategy for capturing momentum profits. The key is to be patient, disciplined, and to trust the process.