Darvas Box Theory
Candlefocus EditorAt its core, the Darvas box theory involves drawing a line along the recent highs and lows of the trading period used. When a stock starts trading above the upper line, the trader buys – and when the stock starts trading below the lower line, the trader sells.
The Darvas box theory is often used in rising markets, as stocks tend to show sustained moves in one direction, allowing traders to identify potential breakouts.
Traders can also hone in on particular sectors, such as banks or travel-related stocks, to identify stocks that are likely to outperform the rest of the market’s general direction.
The strategy works best when a stock is showing momentum and its price is in an upward trend. However, the Darvas box theory is not limited to a specific time period. Traders can observe short-term activity within the box, or use longer-term charts to gauge the trend of the security.
Once the trader buys a stock, they will typically set their target price 30-50% above the current price, while protecting their downside risk. This allows traders to protect their capital, while taking advantage of any upside that may arise from an extended price movement.
The Darvas box theory can be used to capture a rising stock's or sector's momentum and benefit from an increase in its price. However, traders must beware of false breakouts and/or head fakes, as these can lead to a trader entering a wrong position. Therefore, using Darvas box theory requires some market savvy, as well as vigilance for getting out of the position before it starts to move against the trader.