› Darvas Box Strategy - How It Works

Darvas Box Strategy - How It Works

Among the wide variety of different trading strategies, breakthrough methods are extremely popular as they provide trading signals after a crucial event happens in the market, changing the overall technical sentiment and shifting future outlook for an asset price. Rates often fluctuate in a certain range, performing a directionless action for quite a while. Those periods are known as consolidations when buyers of call and put options aren’t able to identify the only winner of the eternal battle. However, the extreme borders of consolidation ranges get breached sooner or later, and that event is exactly the trigger, which starts a new swing of the price, if not a new strong trend into the foreseeable future.

A breakthrough is a game-changing factor for any trading strategy and the theory that we will be discussing is a prime example of this.

Nicolas Darvis, the man behind the theory


This trading method was invented and used by Nicolas Darvas - a Hungarian dancer, who immigrated from Europe during World War II and left an indelible trace in the hall of fame of Wall Street. Apart from his extraordinary performance in dancing, he used to spend countless hours researching the stock market. Mr. Darvas learned how to trade with a comparatively low entry threshold in terms of initial trading account, as well as developed his trading strategy based on several money management rules, fundamental filtering, and technical analysis. As a result, he invented his method of applying mathematical formulas to create a profitable trading process through what would later be referred to as Darvis boxes. In the mid-1950th Nicolas Darvas turned 30 thousand dollars to more than 2 million in just three years by utilizing his method


The theory is built on a momentum strategy. The method uses market momentum theory along with technical analysis to determine when to enter and exit the market using Davis boxes.

Background of the theory developed by Nicolas Darvis


Before readers will dive deep into the ocean of mathematics and explanations how the trading system works, they should understand the environment which forced the developer of the system to create his own set of rules in trading. Nicolas Darvas used to trade stocks at the time when the market had tough requirements related to the full brokerage maintenance of every single deal. Commissions and fees were incredibly high at that time, compared to nowadays. Therefore, the system’s developer had to take into account the fact that he cannot afford to have too many wasted chances for a profitable entry, and his trading positions had to be accurate in terms of the high percentage of deals in the money.


Another point which Darva’s used in his trading approach was preliminary fundamental filtering of stocks watchlist. In simple words, he used to choose industries and sectors which were booming at that time. For example, if nowadays we see the potential of electric cars and artificial intelligence, then Darvas was excited about rockets, technology companies, and other sectors that have grown massively since then. With that in mind, Darvas formulated one of the main rules for his trading

Buy assets which have the most potential to grow


In other words, traders should identify a long-term trend before entering the market. Thanks to the technology revolution and the wide usage of software for trading platforms, modern binary options traders can determine a strong trend with two simple clicks. It’s enough to open trading platform and have a look at the long-term timeframe to make sure the deal is going to be by the trend. Traders should avoid counter-trend positions as they might bring too many losses.

Secondary tools and conditions


One critical observation led Nicolas Darvas to a conclusion, which helped him to become successful. He noticed that breakthroughs, as well as strong trends, start with a spike in the trading volume. That means that besides monitoring daily open, high, low, and close prices, traders should keep in mind a possible change in daily trading volume. Transforming that conclusion to the modern technical analysis, binary options trading, the Darvas box strategy requires a secondary indicator - volume.

Leveraging the box method

The box method uses indicators that do not have any complicated mathematical formulas or exponential smoothing. The only essential action is to determine the consolidation range called a Darvas box. Darvas noted that prices often fluctuate in the same range for quite a while. For instance, a share price does not come out of the range between $50-55 as the daily close prices are printed as follows: 50, 52, 53, 51, 51, 55, 53, 52, 50. This range is exactly the Box. Once an asset price prints a higher value than the upper band of the range - $56 - then the box is considered breached and it’s possible to assume that the next box will be ranging between $55 and $60.


 

That shift comes together with the trading signal to start buying call options with the condition that the overall trend is upwards and there was a spike in trading volume during the breakout. The same approach can be applied to put-options cycles when the Darvas box indicator shifts down after the asset price breached the bottom of the previous range.

 


Here is an example of how the indicator looks like on a daily chart of USD/JPY:



Darvas Box Strategy - How It Works

If you like this strategy, you might also be interested in this Keltner Channel Trading Strategy

Using the box method


This trading method can be used within a multi-timeframe analysis to signal the beginning of trading cycles during strong trends. For example, a pure chart of the price of the U.S. dollar versus the Chinese Yuan (see the screenshot below) shows a strong uptrend on the daily timeframe.

Darvas Box Strategy - How It Works

Using the trading strategy on a bullish breakthrough

The main challenge for a binary options trader wanting to take part in box trading is to determine the perfect moment when it’s time to start buying CALL options. The overall trend is obvious, however, traders keen on increasing the effectiveness of every trading cycle, should keep in mind the goal of reducing the number of losses and maximizing profits at the end of the day. Once the pre-determined ranges and the volume indicators are added to the chart, the picture becomes clearer as every bullish breakthrough signal comes together with a spike in the trading volume, pointing to the most efficient entry-level.


Darvas Box Strategy - How It Works

Using the trading strategy on a shorter timeframe

Another example below is related to different timeframes in terms of analysis and expiration times for binary options. The first screenshot shows perfect entry opportunities to start buying put options for EUR/USD on the daily chart as the bearish breakthrough is in play and the spike of trading volume confirmed the signal. The best signal came in on August 26 as highlighted by the red arrow.


Darvas Box Strategy - How It Works

After getting the trading signal, traders can open an intraday chart of the same asset and start buying put options with a 30-minutes expiration period.

Look at the screenshot below showing what was happening with the EUR/USD currency pair since that day:



Darvas Box Strategy - How It Works

Darvas box trading strategy settings and time frames


As long as every asset class has its performance in the scope of volatility, liquidity, and trading volume, the period of the trading range has to vary. The only requirement is to keep a comparatively short-term range of the period between 3 and 13 bars as a longer period might reduce the number of trading signals significantly. The other factor which influences the choice of the period to operate with is that trend’s momentum and speed, as that is also different in many cases. Therefore, the period of the indicator must come in line with an individual trading strategy, frequency of entries, and money management rules. Binary options traders should keep in mind the risk management and stop a trading cycle if the underlying asset price bounces back to the box previously breached. When it comes to timeframes, this trading method can be applied to any timeframe starting from ultra-short periods of 1-minute charts up to 1 month. A trading signal that occurred on a larger timeframe can also be used to trade on the much shorter expiration time.


Conclusion


The Nicolas Darvas box theory has a simple mathematical approach to finding rangebound periods when an asset price is consolidating for a while. The borders of those ranges create so-called boxes. A breakthrough in the box in any direction might signal the beginning of a new trend and thus a trading cycle. Binary options trader should also consider using additional filtering together with the indicator to increase the efficiency of trading. All Darvas box trading must follow the long-term trend determined earlier. The secondary tool of trading volume allows traders to confirm or deny a breakthrough trading signal, which is much more efficient when it comes together with a spike in the trading volume. Generally, the trading algorithm is quite simple and straightforward, however, it requires strict execution and tight risk management, as well as trading discipline to best capitalize on the box trading strategy.


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