$197.

00

Secrets of the Darvas

Trading System

The Legendary Trading System

Completely Updated & Revised
by Darrin J. Donnelly

- EXPANDED EDITION -

Copyright © 2010 by Shamrock New Media, Inc. All Rights Reserved.

NOTICE:
This is NOT a free e-book!

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Printing out more than one copy or distributing it electronically is prohibited

by international and U.S. copyright laws and treaties, and would subject the
offending party to penalties of up to $100,000 per copy distributed.

You may not copy, redistribute, publish, retransmit, transfer, share, modify or
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IMPORTANT DISCLAIMER:
This publication contains the opinions and ideas of the author and should be used for general
information purposes only. Neither the author nor the publisher is an investment advisory service,
a registered investment advisor, or a broker-dealer. The author and the publisher do not purport to
tell or suggest which securities readers should buy or sell for themselves. The author and
publisher is not engaged in rendering legal, tax, investment, insurance, financial, accounting, or
other professional advice or services. If the reader requires such advice or services, a competent
professional should be consulted. Relevant laws vary from state to state. The strategies outlined in
this publication may not be suitable for every individual, and are not guaranteed or warranted to
produce any particular results.

This publication contains statements and statistics believed to be reliable, but neither the author nor
the publisher can guarantee the accuracy or completeness of any of the information contained in
this publication.

No warranty is made with respect to the accuracy or completeness of the information contained
herein.

You are solely responsible for your own investment decisions and the financial results of those
decisions. Trading and investing has large potential risks. You must be aware of the risks and be
willing to accept them in order to invest in any market. The author and publisher specifically
disclaim any responsibility for any liability, loss, or risk, personal or otherwise, which is incurred
as a consequence, directly or indirectly, of the use and application of any of the contents of this
publication.

The testimonials, earnings examples, and “success stories” used in this publication are exceptional
results and do not apply to the average individual and are not intended to represent or guarantee
that anyone will achieve the same or similar results. Each individual’s success depends on his or
her background, experience, dedication, desire and motivation. As with any business endeavor or
financial transaction, there is an inherent risk of loss of capital and there is no guarantee that you
will earn any money. These testimonials, earnings examples, and “success stories” have not been
checked for accuracy, nor have we verified the claims made. These are not typical results.
Trading involves a high level of risk and you could lose money.

This publication is not officially associated with, endorsed by, affiliated with, or sponsored by any
of the individuals written about in this publication.

The names and identifying characteristics of certain individuals referenced in this publication may
have been changed.

Any opinions expressed in this publication are subject to change without notice. Shamrock New
Media, Inc. and/or companies and individuals affiliated with the DarvasTrader.com site and/or its
services (including Darrin Donnelly and Shamrock New Media, Inc. owners, employees,
subcontractors and writers) may hold positions in the securities and other financial instruments
described on the DarvasTrader.com site and/or distributed through its associated emails that may
be consistent or inconsistent with the commentary, data or other provided information.

Regarding any hypothetical or simulated results referred to in this publication:

CFTC RULE 4.41: Hypothetical or simulated performance results have certain limitations. Unlike
an actual performance record, simulated results do not represent actual trading. Also, since the
trades have not been executed, the results may have under-or-over compensated for the impact, if
any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are
also subject to the fact that they are designed with the benefit of hindsight. No representation is
being made that any account will or is likely to achieve profit or losses similar to those shown.

Charts in this publication courtesy of StockCharts.com.

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 For the latest news, updates, and
discussion regarding the
Darvas Trading System, visit
DarvasTrader.com today!

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TABLE OF CONTENTS:

Introduction: Why the Darvas Trading System? …………………....... 9

Traders vs. Investors ………………………………………………. 9
The 4 Requirements for the Perfect Trading System ……………... 11
The Holy Grail of Trading ………………………………………… 14
Too Good to be True? …………………………………………....... 14
What This Book Will Show You ………………………………….. 15

Chapter 1: Who Was Nicolas Darvas? …………………………………..17

Early Years …………………………………………………………18
Darvas’ First Crisis ………………………………...……………… 19
Darvas’ “Value” Disaster …………………………………………..19
Darvas Finds Trend Trading …………….………………………… 20
Honing His System …………….…………………..……………… 22
$2 Million in Less than 2 Years …………………………………… 23
The Darvas Legacy …………………………..……………………. 24

Chapter 2: Darvas Millionaires …………………………………………. 26

William O’Neil …………………………………………………..... 26
Dan Zanger …………………………………………………………27
David Ryan ………………………………………………………... 28
Gary Smith ………………………………………………………… 28
Gil Morales ………………………………………………………... 29
Ced Moses …………………………………………………………. 29
Timothy Sykes ………………………………………………..…… 29
What They All Have in Common …………………………………. 30
Don’t Listen to the Naysayers ……………………………………...30

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Chapter 3: The D.A.R.V.A.S. System – An Overview …………………. 32
The Darvas Trading System in Darvas’ Own Words ……………... 33
The Darvas Box Theory …………………………………………… 33
The Individual Trader’s Advantage ……………………………….. 34
D – Direction of the Market ……………………………………….. 36
A – Accelerated Earning and Sales ………………………………... 36
R – Relative Price Strength (And Return On Equity) ………...…... 36
V – Volume Increasing ……………………………………………. 37
A – Aggressive Growth Group ……………………………………. 38
S – Sound Base Pattern ……………………………………………. 38

Chapter 4: An Introduction to “Darvas Boxes” ……………………….. 39

Support and Resistance ……………………………………………. 39
Identifying Darvas Boxes …………………………………………. 41
Darvas Boxes in Action …………………………………………… 43
Understanding the Purpose of Darvas Boxes ………………………44

Chapter 5: Beyond the Boxes, Part I:

Identifying Sound Bases …………………………………………………. 47
Recognizing Sound Bases …………………………………………. 48
Flat Base ……………………………………………………………49
Bull Flag …………………………………………………………... 50
Rounded Base ……………………………………………………... 51
Cup With Handle Base ……………………………………………..53
Double Bottom Base ………………………………………………. 54
A Reminder ………………………………………………………... 55

Chapter 6: Identifying Market Trends ………………..………………... 56

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Chapter 7: Beyond the Boxes, Part II:
Identifying New Support Levels ………………………………………… 59
The Best Time to Sell ……………………………………………... 61
Support Levels in Action ………………………………………….. 63
Why 7%? ……………………………………………………...……64
An Important Note ……………………………………….…...…… 64

Chapter 8: The 7 Rules of Buying ………………………………………. 66

Buying Rule No. 1 ………………………………………………… 66
Buying Rule No. 2 ………………………………………………… 67
Buying Rule No. 3 ………………………………………………… 68
Buying Rule No. 4 ………………………………………………… 70
Buying Rule No. 5 ………………………………………………… 70
Buying Rule No. 6 ………………………………………………… 71
Buying Rule No. 7 ………………………………………………… 73

Chapter 9: The 7 Rules of Selling ……………………………………….. 75

Selling Rule No. 1 …………………………………………………. 76
Selling Rule No. 2 …………………………………………………. 78
Selling Rule No. 3 …………………………………………………. 78
Selling Rule No. 4 …………………………………………………. 79
Selling Rule No. 5 …………………………………………………. 80
Selling Rule No. 6 …………………………………………………. 81
Selling Rule No. 7 …………………………………………………. 82

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Chapter 10: The 7 Most Common Mistakes Traders Make ………..…. 83
Mistake No. 1 ……………………………………………………… 83
Mistake No. 2 ……………………………………………………… 84
Mistake No. 3 ……………………………………………………… 85
Mistake No. 4 ……………………………………………………… 86
Mistake No. 5 ……………………………………………………… 86
Mistake No. 6 ……………………………………………………… 87
Mistake No. 7 ……………………………………………………… 88

Chapter 11: Vital Resources …………………………………………….. 89

First and Foremost ………………………………………………… 89
How to Screen For Darvas Stocks ………………………………… 90
Where to Do Your Chart Work ……………………………………. 93
Implementing the System …………………………………………. 94
Recommended Reading …………………………………………… 95
A Final Word ……………………………………………………… 98

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 Introduction:
Why the Darvas Trading System?

The purpose of this book is to show you exactly how to follow one of the most
powerful trading systems ever developed. This system isn’t for everyone, but
those that have mastered it have made fortunes with it.

As they say, “there are a million ways to make a million dollars,” and on Wall
Street, there is certainly no one way to make a lot of money. The Darvas
Trading System may not be ideal for you due to any number of reasons. But
for me and many other traders, I’ve yet to find a better way to make a great
living.

Traders vs. Investors

Primarily, there are two major camps on Wall Street: the buy-and-hold
investors and the fast-money traders.

Neither strategy is inherently superior to the other as each side can claim
historic market heroes who have made millions, if not billions. But, it’s
important for each individual to find the primary style that suits him best and
then follow that style.

The Darvas System is a trading strategy and I believe that a trading approach
has two major advantages over a long-term investing approach, especially if
you’re looking to make a full-time career out of this.

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First, my goal in the market is to make money and if I have a choice between
making money quickly and making money slowly, I prefer to make it quickly.
Holding a stock for years or decades and hoping for an eventual profit simply
doesn’t appeal to me as a primary income source.

All my research has shown me that successful traders consistently build their
fortunes at a much faster rate than successful long-term investors.

Secondly, I like to be hands-on with my investments. I don’t have the

stomach to “ride out a storm” and watch my stocks fall lower and lower while
I hope for a rebound. A trader, unlike an investor, gets out of a position at the
first sign of real trouble. He doesn’t sit through a bearish trend and wonder
how much more money he’ll lose. Instead, he gests out of the market with his
cash intact or he goes short.

Now, there are thousands of different ways to trade, but my exhaustive search
for the right trading system brought me to the Darvas Trading System.

[Author’s Note: Before we end this discussion on trading versus investing, I’d
like to point out that while I’m a Darvas trader first and foremost, I also like to
implement a buy-and-hold, long-term investing strategy in a separate account.
I think of this long-term account as something similar to a real estate portfolio,
something I rarely make changes to. The point is that you don’t have to adopt
one single investment strategy and completely disregard another. In fact, I
think everyone should experiment with and learn from different strategies in
order to become the very best trader they can be. For more on my long-term
approach, please refer to another book I wrote called
The Buffett System for Darvas Traders.]

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The 4 Requirements for the Perfect Trading System

I was looking for a trading system that met four specific requirements and I
found that the Darvas Trading System passed the test of those four
requirements.

No. 1
I was looking for a strategy that had been proven to work in the past. The
Darvas System carried a successful track record of more than 50 years and the
proof wasn’t based on hypothetical, back-tested results, it was based on real
people who mastered the strategy and turned small accounts into huge
fortunes.

I’m much more interested in a system developed by and followed by people

who have actually made real money with it as opposed to a system that a
computer programmer or author claims would have worked in the past.

In this book, you will learn Nicolas Darvas’ amazing success story and the
success stories of several other Darvas Millionaires who learned from him.

No. 2
I wanted a trading system that allowed me to have all the freedom I desired. I
wanted the freedom to travel and relax and enjoy my family. I didn’t want a
trading system that forced me to live in front of a computer at all times.

I’d seen traders who, while they may have made a lot of money, had become
ghosts to the rest of their world due to their 14-hour days glued to eight
different monitors. That wasn’t the life that I wanted. To me, a huge fortune
was worthless if I had to sacrifice my quality of life in order to get it.

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The Darvas Trading System met this requirement as well. Not only did it not
require a person to live his life at a trading desk, but it actually worked best
when you were nowhere near your desk!

Nicolas Darvas traveled the world while he was amassing his multi-million
dollar trading fortune. Needless to say, he bucked the stereotype of a rapid-
fire trader who had no life outside of Wall Street.

Today, I’ve found that to be a successful Darvas System trader, you should
spend just 15-30 minutes per day implementing the system. That’s 15-30
minutes TOTAL and includes research time and actual trade execution.

No. 3
Another requirement for my trading strategy was that I wanted a true,
systematic approach. I didn’t want any emotions, hunches, or feelings to be
involved with my trades. I wanted set-in-stone rules that could be followed at
all times.

I understood that great traders needed to always apply some discretion, but I
wanted this discretion to be minimal.

In the past, I’d always had a very difficult time checking my emotions at the
door and I didn’t want to go down that path again, especially with all the
psychological turmoil that comes with “trusting your gut” on critical trading
decisions.

The Darvas Trading System had what I was looking for here. It was actually
very simple: follow the rules laid out and you’ll be executing it perfectly – it
will take care of you if you let it.

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Of course, this is easier said than done. It is human nature to let our emotions
get involved and second guess our decisions, especially when money is
involved. However, I knew from experience that I hadn’t been very
successful when I traded in this manner. Therefore, I needed a system that
would force me to be disciplined and follow the set rules.

As great traders will tell you, “Rule No. 1 is: Follow your rules!”

No. 4
Finally, I wanted a trading system that limited my losses. I wasn’t interested
in a high-risk strategy that could potentially wipe out everything I had.

Finding a low-risk trading strategy wasn’t easy.

Many trading systems that I came across involved high-leverage futures and
options or “just trust the system” trend following strategies that forced traders
to sit through drawdowns of 50% or more.

These were not for me. I just didn’t have the stomach for them.

I knew that many fortunes had been lost by traders who “held on and hoped”
instead of cutting their losses and moving on.

The Darvas Trading System limits risk. In fact, it’s specifically designed to
limit losses first and make money second.

Darvas himself said, “The best part of the system which I had so painstakingly
devised was not that it had made my fortune. What was infinitely more
important – it had enabled me to keep it!”

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The Holy Grail of Trading

Finding the Darvas System was like finding my “holy grail” of trading. It met
all of my criteria with flying colors:

• It had been proven to work for actual, real-life traders and wasn’t
based on computer back-testing. It had been creating millionaires
from very different backgrounds and in very different market
conditions for 50 years.

• It allowed me to implement the strategy without giving up my freedom

and the things I love in life. I could fully execute the system in just
15-30 minutes per day.

• It had hard, set-in-stone rules that prohibited one from letting his or
her emotions get involved. You would never be asked to rely on gut
feelings. The system would take care of you as long as you followed
the rules.

• And most importantly, it cut losses and limited my risk!

Too Good to Be True?

When you really look at the Darvas Trading System, it sounds almost too
good to be true. And in a way, it is.

You see, even though this book will show you everything you need to know in
order to execute this amazing strategy in just 15-30 minutes a day, I know that
the vast majority of people out there won’t be able to follow it simply because
they lack the discipline to do so.

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It’s simply far too common to second-guess yourself and to not trust the rules
of the system, to become impatient with the system, and to start making
drastic changes. That is precisely why some people have become multi-
millionaires with the Darvas Trading System while most others have scrapped
the strategy and claimed that it didn’t work.

The major difference is discipline.

If you want to succeed with the Darvas Trading System, you must have the
discipline to trust it and follow ALL of its rules.

What This Book Will Show You

You’ll notice that this book is short and to-the-point. I’m not going to waste
your time with stories and theories. I’m not here to “sell” you on the Darvas
System and explain why it is better than any other trading system I know of
(although it undoubtedly is).

Instead, this book will simply and succinctly give you everything you need to
implement the Darvas Trading System.

In the chapters that follow, I will explain to you the origins of the Darvas
System. You’ll learn Nicolas Darvas’ amazing story and how he developed
his strategy. You’ll learn the incredible success stories of Darvas’ most
famous students. You’ll learn how the Darvas Trading System has evolved to
work better in modern market conditions and how today’s technologies make
it easier and more efficient than ever before to apply this phenomenal system.

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In this book, I’ll show you where and how to find Darvas stocks. I’ll show
you exactly how the Darvas System has changed through the years. I’ll show
you when and why to buy and sell your Darvas stocks.
I’ll do all this, but you’ve got to do your part as well.

If you want to succeed, you’ve got to stay disciplined and follow the system’s
rules. This may mean staying completely out of the market for weeks or even
months. This may mean cutting losses so quickly that you’re out of a trade
just moments after you enter it. This also may mean holding a stock for six
months, nine months, maybe even 12 months while you’re tempted every day
to cash in on your 300%+ profit.

Discipline is the biggest key to succeeding with the Darvas Trading System
and by having such discipline, wealth beyond your wildest dreams can be a
reality.

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 Chapter 1:
Who Was Nicolas Darvas?

Nicolas Darvas lived a diverse and success-filled life.

Before he discovered the stock market, Darvas made his living as a world-
touring ballroom dancer. After making his initial multimillion-dollar fortune
as a trader, he became a bestselling author, a successful real estate speculator,
and a partner in numerous business ventures.

His interests were quite diverse as he achieved success in the fashion industry,
theatre production, and even the crossword puzzle business (I had no idea
there was such a business).

But what Darvas was best known for – and what he seemed most passionate
about – was his astounding success in the stock market. He created a stock
trading system that amassed a $2 million fortune in just 18 months and he
continued trading and evolving his system until his final days.

In May of 1959, Time Magazine ran a story on Darvas and shared his amazing
story with the world. In the 50-plus years since his story went public, a lot has
been said about Nicolas Darvas. Some of it true, some of it fabricated.

The point of this chapter – of this brief history of Darvas’ life – is to separate
the fact from the fiction and to provide you, the trader, with a sound
foundation and understanding for why Darvas and his trading methods are
held in such high regard by so many of the world’s top traders.

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This is the true – and amazing – story of Nicolas Darvas.

Early Years

Nicolas Darvas was born in 1920 and raised in Hungary. At the age of 23, he
fled the country with a forged exit visa to escape the Nazis and the Soviets,
who were both trying to take control of his homeland.

Darvas would eventually team up with his half-

sister, Julia, to form the highly-successful
ballroom dance team known as “Darvas and
Julia.” The two took their act around the world
in the 1950s and made several major television
appearances on shows such as Toast of the
Town (which would eventually become The Ed
Sullivan Show).

While on tour in 1952, instead of a normal cash

payment, a Toronto nightclub offered Darvas $3,000 worth of stock in
Brilund, a Canadian mining company. Darvas accepted the offer and
incredibly, the stock took off over the next two months and gave Darvas a
quick $8,000 profit.

Needless to say, Darvas became very interested in the stock market.

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Darvas’ First Crisis

It didn’t take Darvas long to realize just how much pure luck was involved in
that first “trade.”

Over the 14 months after cashing in a huge gain on Brilund, Darvas played the
stock market and slowly gave back more than 60% of the profits he’d gained
on that initial Brilund transaction.

At this point, Darvas was extremely frustrated, but he didn’t give up. Instead,
he became committed to conquering Wall Street.

For nearly three years, Darvas read as much as he possibly could about the
stock market. He devoured more than 200 books on the stock market. He
meticulously analyzed company balance sheets, he studied analyst forecasts,
and he read dozens of investment newsletters. He left no stone unturned in his
quest to beat the Street.

Darvas’ “Value” Disaster

At one point, Darvas’ exhaustive study led him to what he believed was a
hidden treasure in the stock market. He found a company called Jones &
Laughlin that met every conceivable valuation measure. He was absolutely
certain, based on his extensive research, that this company was priced well
below its fair value.

Darvas bet big on his analysis. He mortgaged some property he owned to free
up money for this stock and also became heavily margined in the investment.

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Less than one month later, Darvas had lost nearly 25% on this investment and
he couldn’t take it anymore. He sold at a huge loss.

This was a crisis moment for Darvas. He was now falling into debt and his
confidence was shattered.

Darvas could not fathom how this loss occurred. He had done everything
conventional Wall Street wisdom had told him he should. He had focused on
“value” and he had been meticulous and extensive in his research. But yet,
he’d lost so much so fast on this investment that he was forced to sell his
position for a substantial loss.

This crisis would turn out to be a blessing for Darvas as it would lead him to
the discovery of his own powerful investment strategy. The strategy that
would eventually become known to successful traders around the world
simply as, “The Darvas System.”

Darvas Finds Trend Trading

After his disheartening investment with Jones & Laughlin, Darvas dusted
himself off and started looking for a better strategy. He discovered what is
now commonly known as “trend trading” (also sometimes called “momentum
trading”).

Trend trading is a strategy very different from the more common and more
popular value investing method, which tries to buy low and sell high.

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Instead, the objective of trend trading is to find the most powerful growth
stocks that are already moving higher; stocks that are already on an upward
trend. These are the stocks big institutional investors (mutual funds, hedge
funds, pension funds, etc.) are buying in bulk. Once you recognize these
stocks, you simply climb aboard to ride the trend as their stock prices rise.
The intention is not to buy low and sell high, but rather, to buy high and sell
higher.

Darvas read and re-read books like The Battle for Investment Survival by
Gerald Loeb and Tape Reading and Market Tactics by Humphrey Bancroft
Neill nearly every week. He spent a minimum of eight hours per day
studying stock price movements.

When Darvas wanted to master a skill, he threw himself into it with a

relentless focus on succeeding. He was extremely passionate about achieving
his goals (in any endeavor that interested him).

Darvas put in eight hours a day nearly every single day for three years in an
effort to conquer Wall Street. Is it really any wonder that he devised a system
that achieved his goal?

Those who brush off Darvas’ amazing achievements as a random stroke of

luck fail to appreciate the time, effort, enthusiasm, and study he put into his
trading strategy. His success in the stock market came as a result of what it
takes to succeed in any other field: hard work, long hours, passion, and the
relentless determination to succeed.

Everything Darvas learned went into developing the Darvas Trading System.

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Honing His System

Darvas focused his attention on high-growth stocks that were hitting new
highs and breaking out of price ranges on increased volume. Basically, he
wanted to find stocks that had already been trending higher, but then went
sideways, resting for awhile. When the stocks broke out of this “resting”
price range, Darvas saw that as a sign that the upward trend was poised to go
much higher.

However, Darvas didn’t rely on price movement and volume alone. Darvas
described himself as a “techno-fundamentalist,” focusing on both technical
and fundamental analysis.

Darvas’ new objective was not to rapidly trade in and out of stocks he didn’t
have any knowledge of. He had tried this and failed miserably. He found that
with such a method, not only did the commissions deplete his account, but he
struggled with his timing on these “swing” trades as his travels made him
unable to follow price movements all day as they happened.

Darvas had also stopped trying to find low-priced stocks that were
undervalued; the value investing method. He had tried and failed with value
investing, as seen with the Jones & Laughlin debacle, and he wasn’t about to
repeat his mistakes.

No longer interested in holding a stock for a few years or more, Darvas also
recognized that he wasn’t interested in a system that tried to hold a stock for
only a few days. Instead, Darvas shifted his focus to looking for stocks with
the potential to double, triple, or quadruple over an ideal timeframe of 3-12
months.

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All the pieces finally fell into place for Darvas. He developed his personal
system for finding fundamentally-strong growth stocks and buying them when
they were likely to continue their trend higher. The results of his trading
system would change his life dramatically.

Notice a point of emphasis here. Darvas was undoubtedly aware that fortunes
were being made by value investors, swing traders, and day traders – just as
they are today. But, Darvas recognized that those particular systems were not
best for him.

There is no one way to make good money in the stock market, but a successful
trader needs to find the system that works best for his or her personality,
financial goals, ideal timeframe, and overall flexibility.

$2 Million in Less than 2 Years

During an 18-month period beginning in November 1957, Darvas put his new
system to the test. The results were nothing short of phenomenal as he took
his $30,000 account and turned it into a fortune of more than $2.25 million!
(To put this figure in perspective, it would be equal to $16.8 million in today’s
dollars.)

It’s no wonder that Darvas was able to afford a life that most people dream of,
traveling the world as he pleased. He had homes in London, Paris, and the
South of France. When in the U.S., he made his home at the luxurious Plaza
Hotel in New York City.

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Darvas’ unbelievable stock market success sparked national attention. He was
featured in Time Magazine and he would author several bestselling books
including the Wall Street classic, How I Made $2,000,000 in the Stock Market.

As is the case with most extremely successful people, Darvas’ success also
made him a target for critics.

Many claimed that Darvas was a product of freak luck. Some brokerages
allegedly claimed that Darvas was hurting their business because clients felt
they no longer needed to rely on the advice of their brokers. The American
Stock Exchange went so far as to change its rules and temporarily ban the use
of automatic stop-loss orders because so many such orders flooded the market
after Darvas’ story was publicized.

Yet, Darvas continued to trade successfully until his final days. He also
continued to teach his ever-evolving system by writing books and speaking at
universities.

The Darvas Legacy

Nicolas Darvas died in 1977, but his legacy undoubtedly lives on.

What’s incredible about Darvas and his trading system is that it was not a one-
time occurrence of success. He succeeded with the strategy until the end of
his days, always evolving to new market conditions. He made big money
when the market went up and his system took him out of stocks when the
market went down.

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But perhaps much more significant than
Darvas’ personal success in the stock market
was the success of those who learned from his
teachings and mastered his trading strategy.

There have been numerous “Darvas

Millionaires” who credit Darvas with their
success and I’ve featured a few of these success
stories in the next chapter.

Nicolas Darvas lived a truly amazing life and has been an inspiration to
several generations of traders. He’s sure to be an inspiration for future
generations as well.

Today’s professional Darvas traders, in particular, will always be extremely

grateful to Darvas for his willingness to share his system and help others
succeed with it.

This book will show you how to implement the Darvas System as it now
works and I sincerely hope that you too are able to achieve the incredible
success that Darvas and his students have achieved.

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 Chapter 2:
Darvas Millionaires

Nicolas Darvas created a strategy that turned his personal account of $30,000
into $2.25 million in just 18 months and inspired a generation of traders with
his success. But Darvas went beyond merely inspiring others. He would also
teach others his system and the result is a strategy that has produced 50 years
of phenomenal results for those who put in the time and discipline to master
it.

Perhaps much more significant than Darvas’ personal success in the market
was the success of those who learned from his teachings and mastered his
strategy.

There have been numerous “Darvas Millionaires” who credit Nicolas Darvas
and his system with their success. The purpose of this quick chapter is to give
you a snapshot of just a few of the more famous Darvas-influenced people
who have traded their way to millions and recommended Darvas’ teachings to
others who wish to do the same.

William O’Neil

William O’Neil is probably the most famous name on this list of Darvas
Millionaires.

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From 1962-1963, O’Neil took a $5,000 account and turned it into $200,000.
He used his winnings to buy a seat on the NYSE and never looked back. He
would later become the founder of the highly-respected financial newspaper,
Investors Business Daily, and the powerful investment website,
Investors.com.

O’Neil lists Nicolas Darvas as one of his trading strategy’s primary influences
and recommends that all traders learn from his teachings.

Dan Zanger

Beginning in 1999, over a period of less than two years, Dan Zanger turned
his $10,000 account into $42 million. His amazing story garnered national
attention, but what wasn’t surprising was the method he used to produce such
phenomenal returns.

Zanger quickly become somewhat of a celebrity in trading circles and his

advice was highly sought after. He recommended Darvas’ strategy and told
traders that the Darvas System is, “widely used and followed today by the best
traders in the world, and still this breakout method is little understood by
most…”

His statement could not have been more accurate.

Zanger is still a big advocate of Darvas’ teachings and he tells traders that
applying the Darvas method will “yield fortunes beyond the reader’s wildest
dreams.”

Zanger was listed by Trader Monthly magazine as one of the top 100 traders
in the world with an annual income of $25 million!

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David Ryan

David Ryan got started with a $20,000 account in 1982. He more than
doubled this account in less than one year.

This quick success gave Ryan the confidence to enter the prestigious U.S.
Investing Championship in 1985. He won the event with a return of 161%.
To prove that his performance was not a one-hit wonder, he entered the
competition again in 1986 and, despite finishing in second place, achieved a
gain of 160%.

Ryan ended up winning the event twice and from 1985-1987, he produced a
compounded return of 1,379%!

Not surprisingly, Ryan credits Darvas as being a major influence on his

trading method.

Gary Smith

In 1985, a nearly bankrupt Gary Smith took a meager $2,200 and turned it into
an account that now produces annual profits of more than $190,000.

How did he get started? He credits Nicolas Darvas for having the most impact
on his career as a fulltime trader.

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Gil Morales

In 1999, Gil Morales wowed investment circles with a one-year return of

971%! But how did he do in the bear market that followed? In the period
ending from 1998 through 2005, Morales achieved a total return of
10,904.25%!

Today, Morales is a sought-after fund manager and publicly recommends that

investors learn from Nicolas Darvas’ teachings.

Ced Moses

Ced Moses made a big name for himself when he entered and won the 1991
U.S. Investing Championship with a record-setting return of 379%! He would
go on to start his own hedge fund where triple-digit returns became the norm
and he was named to Nelson’s list of The World's Best Money Managers.

Who does he credit as a major influence on his trading strategy? You guessed
it, Nicolas Darvas.

Timothy Sykes

When Timothy Sykes was 18, he took his Bar Mitzvah gift of $12,415 and
started trading with it. In just three years, at the age of 21, Sykes had traded
that small account into a $1.65 million fortune. He would go on to start his
own hedge fund, which quickly became one of the top-rated funds in the
Barclays Fund Rankings.

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Sykes lists Nicolas Darvas as a key influence on his trading approach and
states succinctly that Darvas’ system is “timeless” and that despite the fact
that Darvas created his system in the late 1950s, “his technique still works to
this day.”

What They All Have in Common

These prolific traders all became well-known for achieving seemingly

impossible returns in a very short period of time. They all started with
relatively small accounts and turned them into fortunes. And they all have
one thing in common: their tremendous respect for the Darvas Trading
System.

Perhaps there is something to this system after all?

It should also be noted that each of the above-mentioned traders chose to

make their stories public by entering contests, writing newsletters or books,
starting hedge funds, and so on. One must wonder just how many Darvas
millionaires are out there who prefer to stay out of the public eye.

Don’t Listen to the Naysayers

I included this chapter in the book for two reasons.

First, I wanted to show how the Darvas System has achieved phenomenal
results for many different individuals in many different market conditions
over the past 50 years.

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I also wanted to include this as a motivator for traders to read and re-read.
The world is full of naysayers and complainers who will assure you that the
success achieved by these Darvas traders is impossible. Remember the
individuals included in this chapter when someone tells you “it can’t be
done.” They are living proof that it can be done again and again.

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 Chapter 3:
The D.A.R.V.A.S. System – An Overview

What is the Darvas System and how has it evolved since being introduced 50
years ago?

For starters, let’s be clear on what it is not.

The Darvas System is NOT just a technical “boxing” system. People have
become so enamored with the famous “Darvas Boxes” that they fail to
understand what these boxes were intended to be and, more importantly, they
disregard the main components of the Darvas System.

The Darvas System is also NOT a day trading strategy. While a Darvas trader
will always cut his losses quickly, most winning trades are held for a period of
several weeks or months.

Nicolas Darvas was only interested in stocks with the potential to double,
triple, or quadruple over the next six to 12 months. He developed a list of
criteria which he found to be most indicative of the potential he was looking
for. Without a doubt, Darvas’ criteria worked as he turned $30,000 into more
than $2 million in less than two years of applying his strategy.

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The Darvas Trading System in Darvas’ Own Words

In his last book, You Can Still Make It in the Market, Darvas tried to clarify
what his system entailed. The following characteristics are presented in their
order of importance according to Darvas:

1- Only buy companies “whose growth and earnings prospects look highly
promising.”

2- Avoid companies that are “already so big that the prospect of any further
substantial growth is highly unlikely.”

3- “Check the overall market trend to ascertain whether stocks in general are
in an uptrend.”

4- “Check whether the stock belongs to a strong industry group, i.e., a group
that is performing well in the market relative to other groups.”

5- Consider the stock only “if it is rising in price on high volume.”

Then, and only after passing these first five requirements, would Darvas
evaluate a stock in light of his “Box Theory.”

The Darvas Box Theory

How does Darvas describe his Box Theory? Simply stated, Darvas writes that
stock price movements are not erratic and random, but rather, “a series of
price ranges or boxes.”

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Notice here that Darvas explains his theory as a series of price ranges OR
boxes, thus implying that the Darvas Boxes shouldn't be applied too rigidly.

We’ll take a closer look at how these Darvas Boxes are defined in the next
chapter. But for now, simply understand that Darvas was looking for stocks
that developed recognizable price ranges – areas of support and resistance.
And, he wanted to see these price ranges trending higher and higher – in other
words, he wanted to see higher highs and higher lows.

That is the Darvas System in its simplest terms.

Wall Street likes to call this style “trend trading” because you buy high-
growth stocks as they move up in price (trending higher) and only sell them
when the stock falls below previous support levels (breaking a trend).

Big institutions – mutual funds, hedge funds, pension funds, trust funds, etc. –
have the ability to drive stock prices quickly and as a Darvas System trend
trader, you’re basically following the trend created by these institutional
moves.

The Individual Trader’s Advantage

This is why an individual trader has a huge advantage over a large

institutional fund manager. Because of their size, institutions are unable to get
in and out of positions quickly, but an individual trader has this capability.

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An individual can ride the trend on the way up and easily get out before the
institutions have time to unload their huge positions. This is also why it can
be difficult to achieve huge returns with the Darvas System once you’re
dealing with an account of more than $50 million. (Of course, having an
account that large would be a good problem to have for most individual
traders.)

Some of you may be noticing the many similarities between the Darvas
System and William J. O’Neil’s popular CAN SLIM system. O’Neil was
heavily influenced by Darvas’ teachings, so this is no accident.

However, while O’Neil is a brilliant trader who has helped thousands make
better investment decisions, I feel that there are some aspects of the CAN
SLIM system that, frankly, aren’t all that important in picking winning
stocks.

Therefore, we offer a new, easy-to-remember acronym for the Darvas System:

D – Direction of the Market

A – Accelerated Earnings and Sales
R – Relative Price Strength (and Return on Equity)
V – Volume Increasing
A – Aggressive Growth Group
S – Sound Base Pattern

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To further explain:

D – Direction of the Market

Is the market, as a whole, in an uptrend? It is highly unlikely that a stock will

have huge gains when the overall market is in a downtrend, so make sure the
direction of the market is moving upward.

A – Accelerated Earnings and Sales

Is the company seeing increases in earnings and sales this quarter compared to
the same quarter last year?

You want to see stocks with at least 40% increases in earning AND sales in
the most recent quarter compared to the same quarter last year. And
remember, the higher the increase in earnings and sales, the better. If you
have a choice between a stock with a 50% increase and one with a 90%
increase, definitely go with the 90% increase stock.

R – Relative Price Strength (and Return on Equity)

Is the stock outperforming most other stocks in terms of its price increase?

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Darvas wanted to see stocks that had at least doubled over the past year before
he’d consider buying. If a stock has already increased a great deal over the
past year, most investors are fearful of a steep decline, but many studies have
shown that Darvas was right in his assessment; if a stock had already made a
powerful move, it proved that it had the ability to move in such a fashion and
therefore, was likely to do it again.

Another important characteristic of ideal Darvas stocks is a high Return on

Equity. Fund managers love to see a high ROE. Some put a higher value on
ROE than they do earnings and sales.

William O’Neil conducted a 50-year study on top performing stocks. This

study’s findings were published in his classic book How to Make Money in
Stocks. O’Neil found that almost all of what he labeled “the greatest growth
stocks of the past years” began their runs with a Return on Equity of 17% or
higher. And just like when it comes to earnings and sales, the higher the ROE
is, the better outlook for the stock.

Therefore, with the exception of rare cases when earnings or other conditions
are extremely attractive, we should primarily buy stocks with a ROE of 17%
of higher.

V – Volume Increasing

Is volume increasing on up days, particularly on the day when the stock

breaks into new highs?

Volume can tell you so much about a stock. Ideally, you want to see much
higher-than-normal volume when a stock breaks into new highs and lower
volume when the stock declines.

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A – Aggressive Growth Group

Is the stock a member of an industry group that has been increasing in price
more rapidly than most other groups?

At any given time in the market, there are certain groups and sectors that are
very hot. It’s always been this way and always will be this way. Make sure
your stocks are members of these hot groups.

S – Sound Base Pattern

Is the stock breaking out of a sound base pattern?

You want to buy stocks that are breaking out of old price ranges and into new,
higher price ranges. You also want to sell stocks that are falling down into
lower price ranges. These price ranges may be strictly applied Darvas Boxes
or one of the other proven base patterns explained in later in this book.

If a stock meets all of the above criteria, it is potentially a huge winner.

Remember, as Darvas said, the only reason to buy a stock is if this price of
that stock is going up. He was only interested in stocks that could double,
triple, or quadruple over the next six to 12 months.

If you concentrate your stock selections to these types of stocks, you too may
soon join the ever-growing list of Darvas Millionaires.

Unfortunately, most traders lack the discipline to stick with these strict
requirements.

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 Chapter 4:
An Introduction to “Darvas Boxes”

Before we get into this explanation of what “Darvas Boxes” are, I want to
reiterate that one of the biggest mistakes Darvas followers make is relying too
much on these technical Darvas Boxes and disregarding the main components
of the Darvas System. While the Darvas Boxes are easily the most talked
about aspect of the Darvas System, you will not succeed without
understanding the entire system.

Having said all that, it is vitally important when implementing the Darvas
System that you understand the concept of Darvas Boxes.

After a stock first met all the Darvas System fundamental requirements,
Nicolas Darvas would then apply his technical “Box Theory.” He found that
stock price movements were not erratic and random, but rather, “a series of
price ranges.” Darvas Boxes were simply Darvas’ method of identifying these
price ranges.

Support and Resistance

Darvas wanted to identify key points of support and resistance in the price
range of a stock. The top of the box would identify the stock’s resistance
level – the price point at which, at least temporarily, there are no more buyers
to be found. The bottom of the box would identify the stock’s support level –
the price point at which there are no more sellers to be found.

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Darvas was looking for stocks that developed these definable price ranges –
areas of support and resistance – and he wanted to see these price ranges
going higher and higher; that is, higher highs and higher lows.

Based on these boxes, Darvas would buy a stock as it propelled up through a

box top and he would often sell a stock if it dropped below a box bottom. In
other words, he would buy a stock if it broke through previous resistance
levels and sell a stock if it fell through previous support levels.

For example, if a stock was spending days or weeks moving up and down
between 30 and 35, Darvas would define the Darvas Box as a 30-35 box. The
top of the box, 35, would be the resistance level where the price stopped
moving up. The bottom of the box, 30, would be the support level where the
stock stopped moving down.

If the stock moved above 35, it was time to purchase. Once Darvas owned the
stock at, say, $35.10, he would then wait to see where the new price range was
established. If the stock moved up and down between 38 and 42 for several
days or weeks, the stock was now in a 38-42 box and would be held as long as
it stayed in this price range or moved higher.

If the stock broke out above 42, the stock would be establishing a new, higher
box and may be considered for an additional buy. If the stock fell below 38,
the stock would be sold.

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The following chart is of ICE in November and December of 2006. I’ve
identified the support and resistance levels to make it clear. As you can see,
these levels aren’t all that difficult to establish:

Identifying Darvas Boxes

There has been plenty of debate about how exactly Darvas identified the top
and bottom of his boxes. In his writings, Darvas’ most specific answer came
in the revised 1971 edition of How I Made $2,000,000 in the Stock Market. In
a Q&A segment new for the revised edition, Darvas explains his box tops and
bottoms as follows:

“The top of the box is established when the stock does not touch or penetrate a
previously set new high for three consecutive days. This is true – in reverse –
for the bottom of the box.”

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In analyzing these comments, we understand that the box top takes a minimum
of four days be identified.

For example, let’s say that on Day 1, a stock hits a high of $61. On Day 2, the
high is $59, Day 3’s high is $60, and Day 4’s high is $60.50. At this point, we
can see that the previously set high of $61 was not touched or penetrated for
three consecutive days. Thus, the top of the box is $61.

While there is some debate about whether the top of the box could be
established in just three days (that is, including the day the high is made as
one of the three consecutive days required for the top to be established),
Darvas makes it quite clear in the above statement that the high had to be set
prior to the three consecutive days of not being penetrated.

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Darvas Boxes in Action

Let’s take a look at a real example of traditional “Darvas Boxes” in action. In

the following six-month chart of ISRG in 2005-2006, we see that seven
traditional Darvas Boxes were formed. The Darvas Boxes are shaded blue.

Darvas would normally base his buy and sell signals on how the stock price
moved in accordance with these boxes. In the ISRG example above, Darvas
would likely have bought as the stock gapped out of Box B.

By strictly following the traditional Darvas Boxes and their corresponding

rules, one would have held the stock until the stock price fell below the
bottom of Box E because the bottom of each box served as the stop-loss.

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(A stop-loss is a tool where the trader sets an automatic sell stop. This means
that when the price of the stock hits the price set by the trader for his sell stop,
the stock is automatically sold, even if the trader was nowhere near his
computer or a phone to manually sell the stock. This tool is a key component
to the Darvas Trading System as it makes sure that your risk is always limited
– because a stock will always be sold if it falls to a certain price point – and it
allows you to implement the system without being glued to a computer at all
times.)

As you can see in the ISRG example, the Darvas System would have resulted
in a substantial profit in roughly three months holding time.

Understanding the Purpose of Darvas Boxes

While these traditional Darvas Box rules are extremely helpful and they can
be very profitable, it’s important to understand that they should not be relied
on fully for your technical buy and sell signals, especially in today’s more
volatile market. After all, Darvas himself acknowledged that while these
boxes were a good basic strategy, he didn’t strictly adhere to the Box Theory.

Darvas sometimes decided to let his stocks fall below the box bottom without
selling or he’d sell a stock while it stood in the middle of a box. He made
exceptions to his strict Box Theory based on the particular price action of the
stock he was holding.

As you can see in the above ISRG example, there is a long stretch between
Box B and Box C with no boxes being formed. This could be a real problem
for many traders who would prefer to identify new support levels for a sell
point as the stock climbs.

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Also, why did Darvas decide to make four days the minimum for establishing
a box? Why not five or six or just two?

The fact is, in some market environments, using six or seven days would be
much more profitable in establishing boxes. In other environments, the two-
or three-day rule is much more appropriate.

These specifics can be argued endlessly, but what is most important is to

understand the PURPOSE of the Box Theory: identifying support and
resistance levels.

Darvas’ rules for establishing the Darvas Boxes made sure that he would be
much less likely to sell a stock that was still moving up. He wanted to ride the
trend for as long as he could.

Most novice traders have a tendency to sell a stock too quickly because they
“don't want to be too greedy.” Darvas himself ran into this problem and
realized that he would often sell a stock for a small profit, only to watch the
stock go on to establish huge gains that he missed out on. By defining support
and resistance levels, he helped ensure that the stock itself would let him
know if it was running out of momentum and breaking the upward trend.

Darvas knew he couldn’t predict whether or not the stock was done moving
up and ready to retreat, so he relied on his technical analysis to tell him what
to do. Of course, even using the rules Darvas created, you will often sell a
stock only to watch it go on to make further gains, but these rules drastically
cut down on the number of instances you will see this occur.

The key with Darvas Boxes is not getting so enamored with what is actually
identified as a strict Darvas Box to the point that you fail to understand the
principles behind support, resistance, and following the trend.

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Don’t get so caught up in the specifics of how many days are required to
establish a box. Nicolas Darvas himself didn’t.

Instead, just make sure you understand the concept of identifying new areas of
support and resistance. Strict Darvas Boxes or Flat Bases aren’t always the
best way to do this. There are a handful of other extremely powerful base
patterns you should be aware of and a few specific base characteristics that
will drastically increase your rate of success in technical analysis.

Further discussion on these patterns and characteristics can be found in the

next chapter.

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 Chapter 5:
Beyond the Boxes, Part I:
Identifying Sound Bases

It’s very important that you understand the concept of Darvas’ famous
“Boxes.” That is, you need to be able to identify points of support and
resistance in a stock’s price range.

Once you understand how to do so, you’ll be able to recognize what a sound
base is. And once you’re able to recognize a sound base, you will know how
to buy and sell at the best time possible – making your trades extremely
profitable. The purpose of this chapter is to help you do just that.

As pointed out in the previous chapter, the point of recognizing support and
resistance levels is to identify buy and sell points in a trade. If a stock breaks
through a resistance level, it’s time to buy that stock. Conversely, if a stock
breaks below a support level, it’s time to sell. When a stock shows a clear
resistance point and support point, a base has been formed.

When a stock breaks out of a sound base, Darvas System traders know it’s
time to buy. When a stock pulls back and falls through the bottom of a base,
it’s time to get out of the stock because more often than not, it’s done
advancing for the near future.

What do these bases look like and what characteristics does a SOUND base
have?

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Recognizing Sound Bases

First and foremost, Darvas System traders are only interested in bases which
are forming on an already advancing stock. We’re looking for stocks that
have already climbed a great deal and are now forming their bases near new
price highs. Often times, this means that a stock is forming a new base after it
has already climbed 100% or more during the past year.

Another factor to consider is the time it takes for a base to form. Numerous
extensive studies have confirmed that the most reliable bases to make an
initial buy from take – AT THE VERY LEAST – four weeks to form and most
take longer. Short bases formed in only a week or two have a much higher
failure rate, especially when making an initial purchase.

There are times, such as during an extremely exuberant bull market like the
one in 1999, when the market environment may dictate an exception to this
rule. However, these environments are very, very rare.

As a rule, you should only pay attention to bases that have formed over the
course of at least four weeks.

Volume also tells us a lot about a base. A sound base will see volume dry up
while it’s forming. This tells us that there are fewer and fewer sellers to be
found.

It’s also extremely important to remember that you should ONLY buy a stock
breaking out of its base if the volume is much higher than normal on the day
of the breakout (at least 50% above its average level, but preferably 100% or
more above its average level).

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There are five, and only five, sound base patterns that you need to be aware
of.

Flat Base

Sound bases can take a few different shapes. They don’t have to actually look
like a box or rectangle. However, Darvas Boxes, in general, identify the very
solid base pattern known as the Flat Base. These Flat Bases do, in fact, look
similar to a box or rectangle.

The Flat Base, like all sound bases, is formed after an uptrend. The stock then
trades back and forth within a fairly tight trading range over several weeks.
Usually, the support and resistance levels of this tight base will not be further
than 10-15% apart.

Here’s an example of a Flat Base:

Notice how the stock was moving up and then it built its tight base between
$66 (support level) and $70 (resistance level). As soon as the stock breaks
through its resistance level at $70, we see that it’s off to the races.

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Bull Flag

A variation of the Flat Base is the extremely powerful base known as the Bull
Flag. A study of Darvas’ actual trades shows that Bull Flags were definitely
his pattern of choice.

A Bull Flag occurs after a stock has advanced extremely fast – often doubling
in a month or two. The stock then forms a new Flat Base that is normally
rather short. When the stock breaks through this Bull Flag base, it usually
picks up right where it left off, once again taking off for a rapid advance.

Here’s an example:

As you can see, the ideal time to buy would be when the stock hits new highs
as it crosses the top blue line. The Bull Flag is probably the most powerful
base pattern. This is where huge, fast gains can often come from. It’s no
wonder why this was one of Nicolas Darvas’ most coveted patterns.

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Rounded Base

Some base patterns don’t actually form a box or rectangle-shaped pattern of

price movement. In fact, bases that form a rounded bottom are often some of
the most powerful you will find.

This rounded look forms when the sellers dry up and the buyers start coming
back into the stock. Like all sound bases, you want to see volume decrease,
for the most part, as this pattern forms.

Here’s an example of a Rounded Base:

As noted in the chart, you’d buy as the stock hits new highs breaking out of
the base – right as it penetrates the top blue line.

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In the following example, we see a series of several Rounded Bases as this
stock climbs, giving us several buying opportunities if we missed a previous
buy point:

The support and resistance levels would be identified as follows:

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Cup With Handle Base

A Cup With Handle Base was brought to national attention by the Darvas-
influenced founder of Investors Business Daily, William O’Neil. This
extremely powerful base pattern is a variation of the Rounded Base. Instead
of rounding out and then climbing to new highs without much of a pullback,
the stock hesitates just before it reaches new highs and sells off a bit, getting
rid of a final few weak sellers and forming what looks like a “handle” on a
cup (the “cup” being the normal Rounded Base).

This base pattern rarely forms in less than eight to 12 weeks and will
sometimes take many months to form.

In the example below, please note that I am using a weekly chart and not a
daily chart as used in our other examples:

As you can see, you would buy the stock as it cleared the top of its HANDLE
in the Cup With Handle Base. This is a case where you wouldn’t have to wait
for new highs to buy the stock.
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Double Bottom Base

Our final sound base pattern is known as the Double Bottom Base. Unlike the
Flat Base, this pattern forms when a sell-off occurs a bit more sharply. And
unlike the Rounded Base, where a nice rounded bottom is formed before
advancing, the stock starts to climb, but then pulls back once again to form a
“W”-like base bottom.

The buy point on this pattern doesn’t need to be at new highs. Instead, the
buy point occurs when the stock climbs above the midpoint of the “W” in the
pattern:

And of course, as with all base patterns, volume must increase a great deal on
the day the stock breaks through its buy point.

Those are the five sound base patterns that you need to be able to recognize.
Some technical analysts will rattle off hundreds of other patterns that you
must know, but if you’re looking for sound base patterns that have proven to
be the most reliable precursors to huge winners, these are the only five
patterns you need to master.

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A Reminder

Make sure you understand that in our initial search for solid bases, we’re
looking for buy points as a stock breaks through a resistance level. However,
it’s just as important to continue to recognize bases formed on the stocks
you’re holding so that you can sell if the stock falls through a support level.

Identifying support levels is the subject of Chapter 7, but before we get into
that, let’s look at how we identify market trends.

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 Chapter 6:
Identifying Market Trends

The market must be in an uptrend before you should enter a position, but how
do you know when the market is in an uptrend?

The best way I know is to look at a market chart and evaluate the market in
terms of Stan Weinstein’s market stage analysis, as he described in his
excellent book Secrets for Profiting in Bull and Bear Markets.

Stage analysis is very simple.

When the market is in Stage 1, it’s coming off a clear downtrend and it
flattening out.

In Stage 2, the market is clearly heading higher.

In Stage 3, the market is flattening out after a considerable uptrend.

And in Stage 4, the market is in a clear downtrend.

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Here’s an example of market stages on a weekly chart of the S&P 500:

In looking at the above example, two factors may jump out at you.

1) Stage 4s can happen extremely fast.

2) It can be rather difficult to identify a Stage 1 or Stage 3. After all, a Stage 1

could easily be a quick flattening out zone before Stage 4 continues. On the
other hand, a Stage 3 could easily be a flattening out zone before Stage 2
continues.

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The most important thing to remember is that you should never buy stocks
during a Stage 4 market. In the example above, the Stage 4 was over and
done with quickly, but that is rarely the case. Often times, a Stage 4 can last
several months.

My suggestion is to trade cautiously in a Stage 1 or Stage 3, perhaps taking

positions half the size that you normally would. Then, when the market is in a
clear Stage 2, take full positions.

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 Chapter 7:
Beyond the Boxes, Part II:
Identifying New Support Levels

Knowing when to sell is perhaps the most difficult skill to master in trading.
When we exit a trade, two bad things can happen.

1- We can sell too early and miss out on a lot of profit. For example, if
we sell a stock for a 10% gain, we may initially be satisfied with the
result. But if that stock goes on to make a 100% gain over the
subsequent few months, we will be anything but satisfied. We will
have left 90% of our profit on the table!

2- We can sell too late and give back a lot of our profit. For example, if a
stock goes up 100% for us in a very short period of time, we may be
thrilled. But if that stock suddenly takes a 25% dive on us and we sell
with a 50% gain, we will be anything but thrilled. We will have left
50% of our profit on the table!

In looking at the two bad things that can happen when we sell a stock, one
thing all successful Darvas traders recognize is that it’s better to hold too long
than to sell too quickly (unless a stock falls on us from the start, in which case
you should ALWAYS sell your stock at a predetermined stop-loss below your
purchase price – more on this in Chapter 9).

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In the above hypothetical trade, a 50% gain is obviously better than a 10%
gain. However, that doesn’t mean we would be happy with letting a 100%
gain turn into a 50% gain. Our goal is to sell a stock before we give back too
much of our profits while also making sure that we don’t sell too quickly and
miss out on future profits.

Here’s where I’m going to save you some unneeded heartache: You’re
NEVER going to sell right at the top.

Get rid of the idea that selling a stock that has fallen from its top is somehow a
bad thing. Amateur traders stress about this. They can’t get over that extra
10% they could have cashed in. Professional traders recognize that doing so
is simply part of the game and catching the bulk of a trend.

In most cases, using the Darvas Trading System, you’re going to sell a good
10% below the top of a major price move.

But don’t stress about this.

The goal is not to cash out at the very top of a stock’s run. If that is your goal
(as it is for most amateurs), you’ll find yourself holding on to a stock for too
long as you wait for it to “rebound” back to its previous highs. This is a
losing battle.

Our goal is to sell a stock before we give back too much of our profits while
making sure that we don’t sell too quickly and miss out on future profits. I
don’t have a problem giving back 10% for a 90% profit, but I do have a
problem with giving back 50% for a 50% profit.

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The Best Time to Sell

To accomplish our goal, the best rule I know of is to sell a stock when it falls
below a previous support level.

So how do we identify new support levels?

As discussed previously, many have misunderstood the Darvas System and

rely way too much on the number of days the stock behaves the way it does to
identify support and resistance levels.

This is a mistake. I’ve seen way too many stocks establish a three- or four-
day low, start to move higher for a few days, fall back below their four-day
low, and then take off rapidly.

There is a much better way to establish reliable support levels.

Support levels are not complicated. We simply want to identify the point at
which a stock is unlikely to fall further unless a trend is breaking. Therefore,
it’s important to give our stocks the breathing room they need to establish
dependable support levels.

I have found that the best way to do this is to allow a stock to hit new highs
before identifying new support levels.

Look at any stock chart and you will see that rarely does a stock shoot straight
up for any considerable amount of time. Instead, a stock that rises 50% or
more will often experience minor dips along the way. These dips are support
levels. Each time a stock dips and then establishes a new high, the bottom of
that dip becomes the new support level.

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This raises a logical question: what constitutes a “dip?”

The answer isn’t exactly black and white and varies for each stock based on
the stock’s normal movement.

However, a good rule of thumb is that if a stock dips 7% or more from its high
and then turns around and hits a new high, that low point of the dip will be
your new support level.

For example, let’s say we buy a stock at $50.00 and it climbs to $57.00 before
it starts to pull back. The stock spends a week or so trading near $55.00. This
means nothing to us because the $55.00 point is a perfectly safe trading range.
However, let’s say that the stock then falls to $52.75. At this point, we are
alert and watching the stock closely because it has fallen below $53.01, which
is 7% below our high of $57.00.

We’re now waiting to see what our stock does next. We don’t want to set a
new stop until after it reaches a new high. Sure enough, the stock soon rushes
past the $57.00 mark and we now set a new sell-stop at the low point of the
dip, the support level we saw established at $52.75.

And that’s all there is too it.

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Support Levels in Action

Let’s take a look at a real world example. Remember the chart of ICE from
November/December 2006 that we looked at in Chapter 4? Well, here is a
bigger picture of that chart, this time stretching from October 2006 to March
2007.

In the chart below, I have marked each of the support levels established (red
lines) until we were stopped out (red arrow):

As you can see, the result of this trade was a 58% profit in three and a half
months. Notice how new support levels were established. Every time the
stock dipped 7% or more and then hit new highs, we set new sell stops at the
low point of the dip between new highs. It’s really not at all complicated.

And remember, once new highs have been hit and you’ve established new
support levels, all you do is raise your sell-stop to those new support levels. If
your stock ever falls through your support level, you automatically sell out of
your position.

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Why 7%?
In establishing new support levels, is there something special about a 7% drop
as opposed to, say, a 5% drop?

Not necessarily.

However, it has been my experience as a trader that most of the Darvas stocks
we trade tend to be more volatile than most other stocks. These are high-
growth stocks that are receiving a lot of heat (or Wall Street attention) and are
therefore moving rapidly. A 4% or 5% drop may mean something significant
to your typical Dow Jones Industrial Average heavyweight, but for a Darvas
stock, it’s not uncommon to see such swings in a single day.

The 7% mark is simply a pretty reliable rule of thumb for setting new support
levels. A 10% drop, even for highly-volatile Darvas stocks, is usually a fairly
significant move and waiting for such a big move to establish a support level
is simply too high of a percentage.

Because 5% is usually not quite significant enough for our typical Darvas
stocks and 10% is too extreme, 7% becomes our magic number. Something in
between a drastic price movement and a normal price movement.

An Important Note
Allow me to clarify something here.

Identifying support levels and selling when a stock breaks a support level is
the best rule I know of for selling a stock that is making a profit for us.
However, it is not the ONLY rule you should follow.

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There are times, for instance, when you’ll want to use price targets to exit a
trade with at least a portion of your investment.

There are times when extreme price action occurs with your stock (or the
general market) that tells us to head for the exits immediately, even if our
stock hasn’t slashed a support level.

We’ll discuss all of our selling rules in Chapter 9.

The most important thing to remember on stops is this: once you’ve made
your decision to sell at a certain point, whether the bottom of a base, a moving
average line, or a percentage-based trailing stop, make sure you stick to this
stop and get out when your stock hits the stop. Don’t over-think and over-
analyze it while you hope it turns around and goes higher.

It’s emotionally difficult to sell a stock because we’re always hoping for
higher highs. Having the discipline to stick to your sell rules is what separates
the rich traders from the poor traders.

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 Chapter 8:
The 7 Rules of Buying

Now that you have a firm understanding of how to identify sound bases and
new support levels, it’s time to put the Darvas Trading System into action. To
do this, all you need to do is follow the simple buying and selling rules.

Buying Rule No. 1: Only buy stocks that meet ALL the criteria of the
D.A.R.V.A.S. System.

To review the most important factors:

• Make sure the market is in a Stage 2 uptrend. Looking at a long-term

chart of the market will tell you whether we’re currently in an uptrend
or downtrend.

• With rare exceptions, only consider stocks with at least 40% increases
in earnings and sales in the most recent quarter compared to the same
quarter the previous year.

• Make sure the stock has already doubled during the past 52 weeks.
This tells us that this stock has the ability to really move when it wants
to.

• Focus on stocks with a Return on Equity of 17% or more.

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 • Make sure the stock is in a strong industry group. When preparing to
buy a stock, you want to see several other stocks in the same industry
group or sector performing well. If the stock appears to be the only
one in a group that is performing well, it should be avoided.

• Make sure the stock is coming out of one of the five sound base
patterns detailed in Chapter 5.

Buying Rule No. 2: Buy right as the stock breaks out of a sound base, as
close to the predetermined buy point as possible.

If the buy point is $50.00, you want to buy as soon as the stock hits $50.10
(assuming the volume is there, see Buying Rule No. 3).

You should rarely chase a stock that is more than 5% higher than its buy
point. If that occurs, you missed the move and will have to wait for a new
base or new buy point to be identified. Therefore, as a rule of thumb, if the
buy point is $50.00, the most we’d pay for the stock is $52.50 (5% above
$50.00).

The exception to this “never chase a stock 5% above the buy point” rule is
when the stock has shot up in an explosive gap-up. That is, if the stock
opened the trading day much higher than its closing price from the previous
day.

An explosive gap-up breakout is often a sign of tremendous strength and

therefore warrants a purchase even if it means getting in more than 5% above
your previously determined buy point.

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When a stock jumps too far past its buy point, you may also want to take a
wait-and-see approach and buy into a stock if it falls back into your buying
range. While this is riskier because it means we’re buying a stock that is
falling and therefore could be losing its momentum, there are times when a
stock breaks out, runs up 10% or so, cools off by falling back into our 5%
buying range, and then takes off to higher highs.

I recommend watching how other stocks are behaving in current market

conditions before attempting this “pull back” buying method. If you see a few
other stocks act this way first, you’ll know it’s safer to attempt buying on a
pull back.

Buying Rule No. 3: Make sure that volume is well above average on the
day the stock is breaking past its buy point.

Only consider a purchase if the volume is at least 50% higher than its 50-day
average daily volume. If the volume isn’t there, avoid it. This rule will
greatly increase your success rate.

Remember that it takes massive volume to make big moves. I can’t tell you
how often people disregard this rule and buy a stock that hits its buy point
without strong volume only to watch the stock fall 10-20% in the next week or
two.

Volume must be watched closely when a stock breaks out of its base.

Often times, a stock will experience a huge rush of volume, equal to or much
greater than its average daily volume, as soon as the market opens. At this
time, we can obviously assume that volume will be much higher than normal
for the day as a whole.

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However, it can sometimes be difficult to gauge the day’s expected volume
when the early volume is not so dramatic. If a breakout occurs before we’ve
seen a lot of volume, compared to the stock’s average daily volume, then you
may want to avoid the stock until you see a surge of volume come in.

Or, perhaps you may want to buy a small position and then add to the position
if and when high volume does pour in. If, by the end of the trading session,
the volume did not reach our required minimum of 50% or more above its 50-
day average, then you should sell the small position you took.

You might ask, what happens when a stock breaks out of its base, but the
volume doesn’t meet our requirements, do we remove it from our watchlist?
The answer depends.

If the stock hits the buy point without the required volume and keeps going
higher and higher, then go ahead and forget about it until it forms a new sound
base. As per Buying Rule No. 2, you don’t want to chase a stock.

On the other hand, if the stock hits the buy point without the required volume
and then promptly falls back into its original base, then you should keep a
close eye on it. If a couple days later it again breaks out and this time has the
required volume, go ahead and buy it.

In this situation, it’s normally a good idea to make sure the stock actually hits
new highs before buying. For example, if the original buy point was $50.00
and the stock tried to break out with weak volume and climbed as high as
$50.75 before declining, then the new buy point would be $51.00.

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Buying Rule No. 4: Focus on stocks at or very close to new highs.

When a stock hits a new 52-week high, the sky is the limit. There is no
resistance level above it, which means the stock is free to take off. You want
to make sure most of your buys points are at a point where the stock hits a
new 52-week high.

The only exception is when the stock is coming out of a sound Cup With
Handle Base or Double Bottom Base. With these two patterns, the buy point
may not quite be at a new high, but is very close to one.

Buying Rule No. 5: Don’t risk too much on an initial buy. (aka “The 2%
Rule”)

When you’re making your initial buy, make sure to limit your “worst case
scenario” loss to no more than 2% of your trading account.

Your “worst case scenario” loss is the amount you would lose if the stock’s
breakout fails and you get stopped out (we’ll be discussing initial stops and
trailing stops in the next chapter).

For example, let’s say you have $100,000 in your trading account. Following
our 2% rule, you would not allow yourself to lose more than $2,000 on your
initial buy. If your “worst case scenario” stop loss is placed $5 below your
buy point, that means you would buy no more than 400 shares of this stock
(400 shares multiplied by $5 equals $2,000).

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This 2% keeps you out of trouble even if you hit a major losing streak because
each subsequent loss will be less than the previous loss in total dollars
(obviously, as your account shrinks, so would what 2% of the account
represents). All traders will hit losing streaks from time to time and staying
alive is the name of the game for professional traders.

Buying Rule No. 6: Learn to pyramid your buys.

You’re probably going to see 50% or more of all the trades you make with
this system end with a small loss like that discussed in Buying Rule No. 5.
What makes this system so successful is that you cut your losses quick and let
you winners ride on huge trends. Therefore, “pyramiding” your buys is a very
smart way to enter a position.

This means that you should purchase your initial position right as the stock
hits its buy point and then add smaller amounts to the position as it climbs
above the buy point.

There is no set-in-stone rule as far as exactly when to add to a position. A

good rule of thumb is to add as the stock crosses potential resistance points,
such as a nearby round dollar amount (like $50.00 or $55.00).

Another good rule is to wait a few days, watch how the stock is acting, and if
it’s holding above your buy point, go ahead and add to your position.

Yet another good time to add is when the stock breaks through new resistance
points that it establishes with new Sound Bases or simply new highs after
establishing a higher support level.

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There IS one set-in-stone rule regarding how much you should add to your
pyramiding position. That rule is this: don’t ever allow yourself to lose more
than 2% should your stock drop and hit your trailing stop. This means that
you can never add to a trade without first raising your trailing stop to the point
that it will keep our 2% rule intact.

Winning trades turn into losing trades all the time. It’s part of the game. A
stock will take off and everything will look great before suddenly, the stock
reverses and stops you out.

When you’re pyramiding, you’re adding to a winning trade. But with each
additional dollar you invest in the trade, you’re risking more of your account’s
capital. To make sure that you don’t get into serious trouble or have too much
capital in one stock, simply raise your trailing stops before pyramiding.

You should then never add so much capital to one trade that it would result in
a loss of more than 2% of your account should the trade reverse and hit your
trailing stop.

Of course, the higher your stock rises, the more money you can invest without
worrying about losing 2% of your account on the trade.

In these cases, is there a limit to how much you should have invested in any
one trade?

This varies with each trader’s tolerance for risk. Some traders will risk as
much as 50% of their trading account on one stock. This is extremely risky,
of course, because there are times when the unthinkable happens and
extremely bad news forces a stock to gap down, well below your trailing
stops.

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For this reason, I think a good rule is to never allow one single trade account
for more than 25% of your trading account.

Which brings us to the final Darvas System buying rule…

Buying Rule No. 7: Focus your buys to a small selection of stocks.

Darvas traders should always focus on a small number of stocks.

In most circumstances, depending on the size of your trading account, you’ll

only want to be holding four to 10 stocks at any given time. The more money
you have in your trading account, the more stocks you should allow yourself
to trade. The reason for this expansion is that the more money you have
invested in any single stock, the more difficult it becomes to get out of the
stock quickly and at the price you desire.

The following is a good basic rule for how many stocks you should be
holding:

• If your trading account is less than $20,000, allow for a total of four
positions.

• If your trading account is between $20,000 and $100,000, allow for a

total of five positions.

• If your trading account is between $100,000 and $200,000, allow for a

total of six positions.

• If your trading account is between $200,000 and $500,000, allow for a

total of seven positions.

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 • If your trading account is between $500,000 and $2 million, allow for
a total of eight positions.

• If your trading account is $2 million or more, take a total of 10

positions.

These figures are intended for your “total” trading account. So, if you have
$20,000 in an account, but you decide to use 100% margin, your “total”
trading account is obviously $40,000. If you decide to use 50% margin, your
“total” trading account would equal $30,000, etc.

(PLEASE NOTE: You should NEVER go on margin until you’ve gained a

great deal of trading experience. I tell traders they should prove they can
double their trading account without using margin before even considering the
use of margin.)

An important thing to remember when managing your money and the number
of positions you have is that you need to know the total potential dollar
amount you’re working with before deciding how many stocks you’re buying.

Obviously, you will rarely buy all four or five (or whatever number) of your
positions at the same time, so you have to know in advance how much you
will be allocating to each trade. If you’ve got a $30,000 “total” trading
account, you’ll be taking five positions at the most and that means that you
should allow for each position to end up costing you no more than $6,000.

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 Chapter 9:
The 7 Rules of Selling

Knowing when to sell, I believe, is the hardest part of trading. To make better
sell decisions, you need to take the emotions out of it. You need to rely on
strict rules.

Following the seven rules in this chapter will make your sell decisions for
you.

This is a point worth repeating: You have to follow your rules!

Don’t let your ego get in the way. Don’t let fear and greed and other
instinctual emotions mess with your decisions. Your number one priority is to
protect the money you already have and you don’t want to ride a loser lower
and lower. You also don’t want to watch a big winner turn into a small
winner or even…a loser.

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Selling Rule No. 1: Always sell your entire position if the stock falls below
a predetermined amount from your initial buy point.

Don’t feel bad about “losing” on a trade. I’m going to save you the suspense
and let you know that you will probably “lose” on at least half of your trades
following this system. But, the key here is that if you follow the Darvas
System’s rules and cut your losses as advised in this book, you will make a lot
more on your “wins” than you will lose on your “losses.”

And that – in a nutshell – is what makes any trend trading system so

profitable. Especially the Darvas System.

Before you purchase a stock, you need to set your “worst case scenario” stop-
loss. This is the price that you will sell at if your stock doesn’t rise as you
hope and instead fails its breakout attempt.

This can be a tricky situation because some stocks can break out, fall below
the breakout point, and then turn around and take off on a huge run. If you
give too little room for the stock to pull back, you could be stopped out
prematurely and miss out on a hugely successful trade.

However, if you allow too much room for the stock to fall, you could take a
much larger loss than you should have on a stock that fails its breakout and
never succeeds.

So how much room should you give your stock on a breakout attempt?

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Many traders recommend a certain percentage. Nicolas Darvas himself
advised setting an initial stop-loss 10% under the buy point. William O’Neil
advises traders to use an 8% stop loss (he advised 7% for many years, but
increased it to 8% more recently). A lot of very successful traders advise
using a simple 5% stop-loss.

And still, other professionals use a dollar amount for a stop-loss. The Darvas-
influenced multimillionaire trader Dan Zanger recommends selling if a stock
ever falls $1 below your buy point – a little more if it’s an expensive stock,
but never more than $2 below your buy point.

I feel setting an initial stop based on a certain percentage or dollar amount is a

bit arbitrary because each stock behaves differently. For some stocks, $3
swings are quite natural, as are 5% falls followed by 10% bursts. (Please note
that we’re talking about initial stop-losses here and not trailing stops that are
added at points of support during a stocks upward trend. In other words, don’t
confuse this with the 7% rule for establishing new support levels that we
talked about in Chapter 7.)

Instead, I recommend that initial stops be determined in a more logical

fashion. I base stops on the actual base the stock has already formed.

I simply place initial stops halfway between the top of the base (the resistance
level, which is also the target buy point) and the bottom of the base (the
support level).

For instance, if a stock forms a Darvas Box/Flat Base where the top is $50.00
and the bottom is $45.00, I place my initial stop-loss right in the middle, at
$47.50.

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The exact spot you allow a stock to fall can sometimes change depending on
your particular risk assessment or even the current conditions of the market.
But regardless of the method you use to set an initial stop, here’s the key: as
soon as you buy the stock, decide where the exact stop- loss will be placed
and stick with it!

Whatever you do, don’t initially plan on getting out after a 5% loss and then
decide that you’re going to change it to 10% because you have a “feeling” this
stock will turn. Decide initially what your stop will be and don’t change it!

Selling Rule No. 2: As a stock rises, learn to identify new points of

support.

Review Chapter 8 and make sure you know how to identify new support
levels. If these support levels are ever broken, it’s time to sell. This is the
most successful way I know of to sell and keep your profits.

Selling Rule No. 3: Take some of your profits at a price target.

As traders, we’re all looking for that homerun, but a lot of doubles can go a
long way as well.

When you buy into a stock, plan on cashing in 20-25% (perhaps even 50%, if
you choose) of your position when the stock reaches a predetermined price
target.

There’s nothing like ringing the register by cashing in on profits and by

limiting the portion you cash in, you still allow yourself to benefit big if the
trade does in fact become a homerun.

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How do you set your price target? Take the price range of the base, add it to
your buy point, and then cash out when it gets there.

For example, let’s say you have a base with a $50 top and a $40 bottom.
That’s a $10 base. Add that $10 range to the $50 top and you’ve got a price
target of $60.

The nice thing about this method is that if you use the base midpoint as your
initial stop loss (as discussed in Selling Rule No. 1), you basically enter every
trade with a 2-to-1 profit-to-loss expectation. You would have to have twice
as many losing trades as winning trades to NOT make money in the long run.
Winning 50% of your trades, on the other hand, would obviously make you an
extremely successful trader.

[Side Note: If you’ve pyramided into your position prior to this price target
being reached, I advise cashing in 20-25% of your total position at that point.]

Selling Rule No. 4: Sell at least some of your position prior to an earnings
announcement.

Holding a full position during an earnings announcement is way too risky. If

the news is bad, the stock can gap down 10%, 20%, even 30% or more.
There’s nothing worse than waking up in the morning, checking on your
positions, and seeing that you’ve been stopped out 20% below your stop-loss.
This is simply too much risk to take on.

For this reason, you must always be aware of when your company will be
announcing earnings and you should sell half your position before the
announcement.

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If the news is good and the stock jumps higher on the announcement, you can
buy back into a full position immediately. Sure, you’ll miss some of the gain
this way, but a stock is more than likely to continue higher after good news.

Remember this: you can always buy the stock back and ride the new move if
the news is good, but you can’t get back the money you lost if the news is
disappointing.

If a stock doesn’t move excessively one way or the other after an earnings
announcement, I recommend buying back into a full position assuming the
stock still meets all our D.A.R.V.A.S. criteria, including having at least 40%
increases in earnings and sales in the most recent quarter compared to the
same quarter last year.

Selling Rule No. 5: If a stock falls below the 50-day moving average and
stays there for 1-2 weeks or more, it’s time to sell.

The 50-day moving average is a line you must pay close attention to. When a
stock starts trading below this line, it almost always signals the end of a run.

Sometimes, a stock will briefly fall below this line and bounce back quickly as
traders and funds come into buy what they believe is a bargain. For this
reason, we don’t want to blindly sell if our stock touches the 50-day line.
Instead, give your stock a week or even two to try and climb out of it. If the
stock stays below the 50-day line for more than a week or two, go ahead and
sell.

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[Side Note: Why does the 50-day line hold any greater significance than, say,
the 40-day line or 55-day line? The only significance is that fund managers
decided long ago that 50-day lines mattered. They made a habit of letting
some stocks pull back to the 50-day line before adding to their positions,
which would then create a “bouncing” effect when you looked at a stock chart
in relation to the 50-day line. If a stock falls below the 50-day line without
any kind of bounce, then it’s usually a sign the big institutional funds are
losing interest in the stock.]

Selling Rule No. 6: If a stock declines on VERY high volume, it’s time to
sell.

Volume tells us so much about a stock’s strength or weakness. When a stock

climbs on very high volume, it tells us that a lot of buyers are coming in.
Conversely, if a stock falls on heavy volume, it tells us that a lot of sellers are
dumping their positions.

If you see three or more days of high-volume price declines without any high-
volume price increases in-between, it’s time to sell your stock.

And by “high volume” I mean at least 25% above the 50-day average volume
or volume that is much, much higher than the previous day’s volume.

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Selling Rule No. 7: If a stock becomes sluggish and you see a better
opportunity, sell Stock A to buy Stock B.

A stock has become “sluggish” if it hasn’t made new highs for the past 10
days. Now this can usually be very normal behavior as a stock rests up and
gets ready for another run. However, if your portfolio is full and you see
another stock with better earnings and sales breaking out of sound base, go
ahead and sell the “sluggish” stock to make room in your portfolio for the new
breakout.

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 Chapter 10:
The 7 Most Common Mistakes Traders Make

This is the MOST IMPORTANT chapter in this book. If you take nothing else
away from this book, please, PLEASE make sure you’re aware of the seven
most common mistakes traders make.

Making these errors can bankrupt a trading account faster than anything I
know.

Mistake No. 1: Not having rules.

The first and most common error wannabe traders make is not having set-in-
stone rules, not having a system to follow. Too many traders think they can
“get a feel” for their stocks and rely on their gut instincts to make trading
decisions. This is a fatal mistake.

Make sure that you have a system to follow. Needless to say, the Darvas
Trading System is the best trading system I know of.

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Mistake No. 2: Not following your rules.

Want to know what really separates the successful traders from the bankrupt
traders? It’s not how many hours they put in. It’s not the software programs
they have. It’s not how many college degrees they have. It comes down to
one thing: discipline.

It’s one thing to have a proven system, a set of rules that you say you’re going
to follow no matter what, and quite another to actually follow those rules.

Letting your emotions get involved will ruin any trading strategy and it
destroys 99% of all wannabe traders.

Amateur traders are often tempted to “do something” even though the Darvas
System says to hold tight – after all, this seems too easy and surely a great
trader must work extremely hard at what he does and must always stay active
in the market. These traders are gamblers, chasing the excitement and action
of the trade instead of following a proven system.

Darvas taught us that once you have a system that works, stick with it and
don’t second-guess it. He told us it was always better to have set rules to
follow than to rely on intuition or instincts when trading. The money involved
clouds our judgment and making strategy adjustments on the fly will cost you
a lot of money.

To be a successful trader, you’ve got to be disciplined and you’ve got to

follow your rules with NO exceptions. Don’t start second-guessing your
rules. Find a system you believe in and follow it.

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Mistake No. 3: Taking too much risk with margin.

Some traders get into options, futures, and the Forex market where you’re able
to get ridiculously high leverage of 10 times the cash in your account and
higher! If you don’t know what you’re doing in these markets, it’s an easy
way to land in the poorhouse quickly.

Obviously, with the Darvas Trading System, we’re only trading stocks so the
most margin we can typically get is 100% (two times the cash in your
account). However, borrowing this much money can get you into trouble fast
if you’re not extremely careful.

Yes, leverage can be an excellent tool to increase wealth. Obviously, if we’re

fully margined on a stock that goes up 20%, our gain is actually 40%. But on
that same note, if our position goes down 10%, we lose 20%. It doesn’t take
too many 20% losses to wipe you out.

I stated it previously and I’ll state it again: If you’re a beginning trader, stay
away from margin! It can wipe you out very fast. Prove you can trade
without margin before trying to use margin. I recommend to all traders that
they should at least double their account without margin before attempting to
use it.

And always remember, if you do decide to use margin, you don’t always have
to be 100% margined to the max. I personally don’t like to use more than
50% margin, meaning that if I have $100,000 of my cash in an account, I’ll
only borrow $50,000 on margin for a total trading account of $150,000.

Regardless of if you use margin and how much of it you decide to use, make
sure you always follow the 2% rule I showed you in Chapter 8.

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Mistake No. 4: Not cutting your losses quickly.

Most people are tempted to hold their stock just a little while longer, even
though the Darvas System says to sell it. They don’t want to “lose” or “be
wrong” on a trade, so they hold a falling stock, hoping that it will turn around.

Or worse yet, they add to their position with the hopes that when it turns,
they’ll make back their money faster. This is a terrible strategy and it whittles
away at the overwhelming majority of people’s trading accounts.

You’ve got to remember that we don’t care about “winning” or “losing” on

one single trade. In fact, we fully expect to “lose” on 50% of our trades or
more. Our only concern is making sure that our “losses” are very small and
our “wins” are very large. It’s that simple.

Cut your losses and never second-guess your initial stop-loss.

Mistake No. 5: Not having the courage to hit the sidelines in a bad market
environment.

You’ve got to trust the Darvas Trading System and that means hitting the
sidelines and waiting when the market is in a downtrend. This is very hard to
do for many people. The result is that they do very well in a bull market, but
then give it all back – and more! – in a bear market.

So many hopeful traders think they have to be active everyday, that even with
90% of all stocks falling, there must be a few out there they could be making
money on. This thinking is a recipe for disaster. The odds of hitting a winner
in a bad market are way too long and if you are lucky enough to catch one, it’s
highly likely that it will quickly turn into a loser.

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There is a way to make good money in bad markets by going short with a
Darvas-based strategy. But that’s a more advanced topic and we’re not going
to discuss it in this book.

For now, simply master the Darvas Trading System as it’s laid out in this
book and have the courage and discipline to get out of the market when things
look ugly.

Remember that some of the most successful traders in the world refuse to
mess with going short because it’s simply not worth the effort. They use a
bad market to go on vacation and recharge their batteries.

It takes a lot of discipline (there’s that word again) to wait out the storm in a
bad market. The good news is that history has taught us that the market is in
bull mode much more often than it is in bear mode.

Mistake No. 6: Disregarding volume.

You must follow the volume requirements laid out in this book.

Reading a stock’s volume is the key to reading a stock’s strength. Too many
technical traders only pay attention to price movements and this is a fatal
error.

Volume will tell you everything you need to know about the strength of your
stock and by following the rules in this book – especially those dealing with
volume – you’ll greatly increase your potential for success.

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Mistake No. 7: Relying on unproven chart patterns.

Traders often make the mistake of relying on dozens of different chart patterns
that have never been proven to work. As this book has shown, it is extremely
important that a trader be able to identify sound technical chart patterns, but
the five in this book (Chapter 5) are the only five you need to know.

Think about this for a moment; you could look at any stock chart from any
moment in history and identify some kind of supposed pattern that the stock
has made. However, does this mean that the pattern tells us anything reliable
about future expectations for the stock? Of course not.

There’s no sense in trying to learn 50 different inconsistent chart patterns

when there are only five that are necessary to make real money with our
trades.

I think a lot of traders obsess about finding new patterns because they’re
looking for a false sense of security when entering a trade. They can “blame
the pattern” if the trade doesn’t work out for them. Don’t fall into this trap.

Stick with the five reliable base patterns you really need to know. Study them
and become a master at identifying them. Disregard all the rest.

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 Chapter 11:
Vital Resources

The purpose of this final chapter is to give you all the resources you need to
fully implement the Darvas Trading System. Here, I’ll be showing you
exactly how to screen for Darvas Stocks and where you need to go to find the
charts for evaluating Darvas stocks.

I’ll also offer you a few must-read books that you would be wise to study
regularly. Darvas himself never stopped learning.

First and Foremost

Make it a habit to visit DarvasTrader.com. Visit every day and sign up for
the newsletter. It’s all FREE!

I run DarvasTrader.com and comment several times a week on actual trades,

the latest updates on the Darvas System, and any number of other things
dealing with the world of trading. I also love interacting with a community of
like-minded traders.

So before you do anything else, check out DarvasTrader.com and bookmark

it now.

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How to Screen for Darvas Stocks

To begin your search for Darvas stocks, you’ll want to screen for the
fundamentals discussed in this book.

I’ve never understood traders who do this backwards – they go through the
charts first and if they see a chart they like, they then check out the
fundamentals. This seems like a complete waste of time to me. It means
going through hundreds of charts each day even though you know fully well
you won’t buy a stock if the fundamental requirements aren’t there.

Instead, I screen for the fundamentals first and then go to the charts.

When you screen for the fundamentals, you’ll find that the number of stocks
that meet the Darvas System criteria will vary widely based on current
economic conditions. This number can range anywhere from a few stocks in
tough economic times to 30 stocks or more in great economic times.

Once I have these stocks, I can quickly run through their charts to see if
they’re forming a sound base. On average, in a good market, about 5-10 will
either be currently held by me or working on a sound base.

Where do you find these stocks? The easiest place to go would be

DarvasTrader.com, where we’re talking about the latest Darvas stocks every
day.

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Another great resource is Investors Business Daily, the newspaper founded by
the Darvas-influenced trader, William O’Neil. Grab a copy of the Monday
edition, which showcases their IBD 100 and scan through all 100 while
circling the stocks that meet your criteria. You can do the same thing
throughout other editions of the newspaper as they typically showcase the
hottest Darvas-type stocks.

You could also use an online stock screener that you’re comfortable with.
There are several free stock screeners available online from sites such as
Yahoo! Finance and MSN Money.

As far as online screeners go, I personally prefer to screen for Darvas Stocks
through Investors.com, the website for Investors Business Daily. The tool I
use is called the Custom Screen Wizard. The only bummer about this stock
screener is that it isn’t free. It’s a part of the Daily Graphs Complete Equity
Research Package, which runs $112.00 per month as of this writing. I use it
because it’s what I’ve become most comfortable with over the years.

However, I’m not sure how necessary such an expensive screener is when you
can easily scan Investors Business Daily or visit DarvasTrader.com to find
the latest Darvas-type stocks. It’s really a matter of personal preference.

When we begin a screen, we’re looking for stocks that meet all the Darvas
Trading System fundamental requirements that have been laid out for you in
this book.

Let’s take a look at the seven fundamental requirements.

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1. We want stocks that have earnings per share up at least 40% this quarter
over the earnings per share for last year’s same quarter. Make sure that you’re
not comparing consecutive quarters. For example, if you’re using 2009’s 3rd
Quarter results, don’t compare these with 2009’s 2nd Quarter results. Instead,
you’d want to compare them with 2008’s 3rd Quarter results. We want 3rd
Quarter 2009 earnings per share up at least 40% compared to 3rd Quarter 2008
earnings per share.

2. We want stocks that have sales per share up at least 40% this quarter over
the sales per share for last year’s same quarter.

3. We want the stock’s relative strength to be in the top 15%. If you’re using
Investors.com, that means you only want stocks with a relative strength rating
of 85 or better. Most online screeners have some sort of relative strength
screen. If they don’t, just make sure you stick with stocks that have already
doubled in the last year and you’ll be fine.

4. We want stocks with a Return On Equity of 17% or higher. As mentioned

earlier in this book, funds love ROE and a high ROE is an investment bullseye
almost as big as high earnings and sales.

5. We want the stock to be a member of a top industry group or sector. This

means a top 50 industry group or a top 10 sector according to the
Investors.com rankings of industry groups and sectors, which divides the stock
universe into nearly 200 total industry groups and 33 sectors. In other words,
we’re looking for stocks that are in the top quarter or so of all industry groups
or sectors.

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If your stock screener doesn’t rank groups by performance, just make sure that
you can find two or three other stocks within your stock’s industry group that
are also performing well, usually trading near new highs.
6. We want stocks that are priced at $15.00 or higher. Cheap stocks are way
too volatile and are usually cheap for a good reason.

If you buy a stock at $2.00 and it falls $.50, you will have lost one-fourth of
your investment! On the other hand, a $50.00 stock must fall $5.00 before
you lose 10% of your investment.

The more expensive the stock, the better. Not only are more expensive stocks
easier to deal with as far as price fluctuations go, but they are also the ones
that have already shown the ability to move higher. I rarely touch a stock
under $15.00 and prefer to deal only with stocks $50.00 or higher.

7. And finally, we want stocks that have average daily volume of at least
100,000 shares per day. Anything less than 100,000 shares per day and the
stock is probably too volatile for what we’re looking for.

And that’s it for the fundamental screens. Now it’s time to go to the charts.

Where to Do Your Chart Work

The chart service I use is free to all. It’s StockCharts.com and all the charts
included in this book and included on DarvasTrader.com are from that
wonderful service.

When you’re using their charts, there are a couple things you should be aware
of.

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First, you can have their charts define the 50-day moving average line as well
as the 50-day average volume line – two factors that are very important in the
Darvas Trading System.

The 50-day moving average line is included in their default SharpCharts, but
if you don’t notice it, you can turn it on manually. Scroll down below your
chart and under “Overlays” select “Simple Mov. Avg.”. Under “Parameters”
enter “50”.

You can include the 50-day average volume line on your charts by scrolling
down to “Indicators” and selecting “Volume.” Under “Parameters,” enter
“50”. You can then choose whether you want this indicator displayed above
or below your chart.

Once you have the chart set up the way you want, you can click on
“Annotate” right below the displayed chart. This will open up a new window
for you where you can draw lines and bases, make notes, and add pretty much
anything else you’d like included on your charts.

It’s a good idea to get in the habit of drawing your bases on charts, noting
your buy points, sell points, and support levels, and then printing off the charts
to save for future reference. Keep them in a trade journal to look back on and
study.

Implementing the System

Once you’ve gone through the fundamental screen and picked out the stocks
currently trading in sound base patterns, you’ve got your watchlist. This most
likely consists of just a handful of stocks.

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What you’ll want to do with this watchlist is note the stock symbol, the
stock’s 50-day average volume, and the stock’s buy point. Then, either
manually check on your stocks a couple times a day or simply tell your broker
(or set up an automatic trade command with your online brokerage account) to
buy the stock if/when it hits your buy point and meets your volume
requirement as determined by the rules outlined in this book.

Once you’re holding a stock, set an automatic stop sell (either by telling your
broker or setting it up yourself with your online brokerage account) to sell
your stock if it ever hits your sell point. Sell points, of course, are determined
by the rules outlined in this book.

And that’s all there is to it. You can see now why this system takes just 15-30
minutes per day AT THE MOST to implement. Almost everything is
automatic based on the rules in this book.

Recommended Reading

Darvas never stopped trying to learn more about the Wall Street game. You
should learn by his example and continuously read new articles and books
dealing with the world of trading.

Read DarvasTrader.com every day.

Investors Business Daily and/or its sister-site Investors.com is also essential

reading for Darvas traders.

Below I’ve included a list of indispensable books to read:

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How I Made $2,000,000 in the Stock Market
by Nicolas Darvas
The Wall Street classic that gave traders their first glimpse of the Darvas
System. You should read this book at least a dozen times. Not only does it
explain the concept and general method behind the Darvas System, but it also
takes the trader through the psychological battles we all face. You should
read all of Darvas’ books (if you can find them), but this one definitely tops
the list. It is the bible of Darvas System trading.

How to Make Money in Stocks

by William J. O’Neil
The Darvas-influenced William O’Neil wrote this excellent momentum
trading manual. You will be hard-pressed to find a Darvas System trader who
hasn’t also read this book at least a dozen times. Included in the book are
excellent explanations on what to look for in growth stocks and how to
properly read the charts for momentum trading success.

Reminiscences of a Stock Operator

by Edwin Lefevre
A timeless Wall Street classic, this book is basically the autobiography of the
legendary momentum trader, Jesse Livermore. (Edwin Lefevre wrote the
book after spending days interviewing Livermore about his career and his
methods.) Just about every successful trader out there has a copy of this
classic nearby at all times.

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The Battle for Investment Survival
by Gerald Loeb
Another Wall Street classic, this is the book that opened Darvas’ eyes and set
him on the path to creating the Darvas System. It’s an excellent overall
description of how the market works and why momentum trading is the best
strategy to use. Darvas himself made a point to read this book every week to
stay sharp on the lessons it taught.

Secrets for Profiting in Bull and Bear Markets

by Stan Weinstein
This book probably does the best job of explaining the central concepts of
how momentum trading and technical analysis work in very simple language.
Weinstein’s explanations of stage analysis and market cycles is essential
reading.

Market Wizards
by Jack D. Schwager
This book features interview after interview with some of the best traders out
there, including Darvas-influenced successes David Ryan and William
O’Neil. While many of the traders featured in this book have varying
strategies, you can learn essential lessons from each and every one of them.

How Legendary Traders Made Millions

by John Boik
This book takes us through more than a century of Wall Street history while
showcasing the great traders of each era, including Livermore, Loeb, Darvas,
and O’Neil. When you read this book, you clearly see how momentum
trading has always worked – through many different market environments –
and continues to work today.

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A Final Word

I hope that this book will help you achieve trading success beyond your
wildest dreams. Certainly it can be done and you should review Chapter 2
whenever you hit a losing streak and need a little kick-start of motivation.

My only request to you is that as you accomplish your goals and achieve your
success, please remember to share with those around you. Find charities and
good causes to contribute to. Inspire others by doing what you love and
encouraging them to chase their dreams. Always put your family’s needs
first. Help those around you to learn from you and the lessons you’ve learned.

Nicolas Darvas could have squandered his millions and the world would never
have known the difference. But instead, he chose to share his knowledge with
all who care to seek it by writing several books on his trading methods and
speaking at universities.

Just as we follow his trading system, I think we should also follow his
example of sharing with those around us.

In conclusion, never forget these two rules:

1. Be disciplined and follow your trading system’s rules.

2. Never trade with any money you can’t afford to lose.

Thank you for reading this book and I wish you nothing but incredible success
in your market (and life) pursuits. And don’t forget to visit me and other
Darvas traders from around the world at DarvasTrader.com.

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 For the latest news, updates, and
discussion regarding the
Darvas Trading System, visit
DarvasTrader.com today!

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Secrets of the Darvas Trading System by Darrin J. Donnelly 100
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