The Darvas Story: A Synopsis

/The Darvas Story: A Synopsis

Lesson 1 The Darvas Story: A Synopsis

Darvas the Gambler

 

Darvas did not set out to be a gambler; in fact he took his investing very seriously. “Darvas the gambler” is Darvas’ own description of himself once he realized that his approach to investing was no better than gambling. His story begins in November 1952 in

Canada when he and his partner were asked to appear in a Canadian nightclub. Rather than pay in the normal fashion, Darvas was offered 6000 shares in a company named Brilund, a stock that was quoted at 50 cents at the time.

Despite not being able to keep to the arrangement, Darvas bought the stock anyway and paid $3000. Thinking no more about the shares, Darvas was idly skimming the financial press some 2 months later and saw Brilund quoted at $1.92. I believe that Darvas was “hooked” from that moment on. An $8000 profit in two months would make most people salivate.

Working in nightclubs led Darvas to meet various wealthy people whom he asked for advice.

 

“So I asked them, do you know a good stock? Oddly enough, everybody

did seem to know one. It was surprising. Apparently I was the only man in

America who did not have his own first hand stock market information.

I listened eagerly to what they had to say and religiously followed their

tips. What ever I was told to buy, I bought. It took me a long time to

discover that this is one method that never works.”

 

Darvas sought the services of a broker and spent the next year happily buying and selling stocks. In his words he “…jumped in and out of the market like a grasshopper.”

No pets Rex

 

This is not a reference to dogs and cats, rather a very strong warning for all traders. Darvas developed a special liking for some stocks, some because they were given to him and others because he started making money with them. They became “pets”, and he sang their praises but this mentality lasted until he realized that the pet stocks were causing the biggest losses. As with most people who have traded, Darvas found that he was taking small profits and holding onto large losses.

 

While Darvas was excited by the whole industry, delighted with each small win and overlooking his losses, he was not generally trading profitably.

 

“It was a period of wild foolish gambling with no effort to find the

reasons for my operations. I followed hunches. I went by god-sent names,

rumours of uranium finds, oil strikes, anything anyone told me. When

there were constant losses an occasional small gain would give me hope,

like the carrot before the donkey’s nose.”

By the end of 1953, the original stake of $3,000, plus the $8,000 profit from Brilund, had been whittled down to $5,800. Disillusioned but undaunted Darvas decided to give up the Canadian market. He moved to the greener pastures of New York and the allure of Wall Street.

 

Darvas the Fundamentalist

Darvas severed all ties with the Canadian market and decided to start afresh. He topped up his account to a nice round $10,000.

 

After doing his homework Darvas finally decided to dip his toes into the Wall Street market and start trading. His first step was an obvious one and something that no doubt most people have tried without much success.

 

He rang his new broker and:

“Trying to be the old financial hand, simply asked what was good.

I realize now this enquiry was more suitable for a butcher but the broker

was up to it. He suggested several safe stocks.”

 

A few of those stocks began to rise immediately and Darvas was sure that he was on the right track with his new broker. Darvas felt that the broker’s advice was no longer in the “hot tip” category but was valid news based on sound logic and current economic events.

 

Darvas continued to trade constantly. Unfortunately his early success was due primarily to a bull market rather than any wonderful broker research or other insight into the market. It would have been difficult not to choose the odd stock that was rising.

 

Buoyed by his apparent success Darvas began to study books on market terminology and how to trade successfully. He subscribed to as many newsletters and tip sheets as he could find. He became a voracious reader of all things financial. Slowly he began to question the validity of these newsletters. They often contradicted each other; a buy in one tip sheet or newsletter was a sell in another.

 

Compounding his problems Darvas began to realize that brokerage became a major part of each transaction as he jumped in and out of stocks. This led to the realization that many of the old market adages were of no relevance, like “you cannot go broke taking a profit.” Of course you can, if your profits are smaller than your losses. Another is “buy cheap, sell dear.” This seemed like sound logic to Darvas so off he went to buy “cheap” stocks, or stocks that were a bargain and undervalued. Darvas found that these stocks “stuck to his fingers like tar.” Through all these experiences Darvas began to reach certain conclusions. Unlike most potential traders he learned from each series of mistakes. Darvas began to outline some rules that would ultimately be part of the overall plan that led to his great success.

 

  1. I should not follow advisory services. They are not infallible, either in Canada or on Wall Street.

 

  1. I should be cautious with broker’s advice. They can be wrong.
  2. I should ignore Wall Street sayings, no matter how ancient and revered.

 

  1. I should not trade over-the-counter – only in listed stocks where there is always a buyer when I want to sell.

 

  1. I should not listen to rumours, no matter how well founded they may appear.

 

  1. The fundamental approach worked better for me than gambling. I should study it. (How I Made $2,000,000 In the Market, p.34)

 

For months Darvas studied company fundamental information, sifting through dividends, net tangible assets, market capitalization, assets, liabilities and price-earnings ratios. He developed a “wish list” of what he wanted a company to have. Stocks that the experts liked, stocks with a strong cash position but selling below book value and companies who had never cut their dividend.

 

His First Crisis

 

After an enormous amount of research Darvas decided the steel industry would be the one to make him rich. Playing it safe he decided to buy a stock in the steel sector and paying a good dividend.

 

Further research led Darvas to the purchase of 1000 Jones and Laughlin shares because:

  1. It belonged to a strong industry group.

 

  1. It paid almost 6% dividends.

 

  1. Its price-earnings ratio was better than any other stock in that group.

 

 

Darvas had such faith in his analysis that he mortgaged a block of land, borrowed against an insurance policy and bought on a 70% margin. His cost was $52,652.30 (1000 shares at $52 ¼.) This purchase was made on 23rd September 1955.

 

On 26th September 1955 this fool proof theory began to unravel as Jones and Laughlin started to drop. Like most traders he was stunned, paralysed like a rabbit caught in a spotlight. What to do?

 

Based on all the best work Darvas could come up with, J&L was “worth $75.00”.

 

Most traders and brokers decide to hang on when a crisis hits. Darvas was no different. He employed the BHP method (Buy, Hold and Pray). As prices continued to slide he was almost too scared to check the latest quote.

 

Finally Darvas decided to sell his loss was over $9,000. At least at this point Darvas was different from most traders I have seen. He did take a loss but, most importantly, he preserved some of his capital. Many traders wait five or ten years for some sort of recovery. More often than not, they wait until the company enters bankruptcy.

Gambling, tips, research, investigation, whatever Darvas tried did not work. He became desperate. Three years had gone by.

 

Eventually, Darvas noticed a stock – Texas Gulf Producing. He knew nothing about it and had heard no rumours. He simply noticed that the price was rising. Darvas bought Texas Gulf and recouped half the losses from the J&L disaster.

“What, I asked myself, was the value of examining company

reports, studying the industry outlook, the rating, the price-earnings

ratio? The stock that saved me from disaster was one about which I knew

nothing. I picked it for one reason only – it seemed to be rising. Was this

the answer…could it be?”

 

Darvas the Technician

It was time for further reassessment. Darvas admitted that he had tried fundamental analysis without success. However technical analysis had led to profits. He decided to try the successful approach again. He noticed a stock called M&M Woodturning, none of the financial information services could tell him anything and his broker had never heard of it. He remained interested because the price action reminded him of Texas Gulf Producing.

 

In December 1955 the stock rose from about $15.00 to $23.50. After a five-week lull in activity, the price began to climb again, accompanied by an increase in volume. Darvas bought at $26.60. The price continued its rise and Darvas sold at $33.00. Again, he knew nothing of the stock other than the price was rising. Following his sale of M&M Woodturning Darvas found a newspaper report that a takeover was being secretly negotiated.

 

This was a major breakthrough. Darvas was ecstatic, feeling like an insider without being one. This experience convinced Darvas that a purely technical approach was logical. Studying price action and volume could get positive results.

Darvas began buying stocks solely on the basis of an increase in volume and price. Sometimes this was successful and sometimes not. He found that on occasions he would buy a stock only to see it immediately begin to fall, and as soon as he sold, prices would advance. Sounds familiar doesn’t it? As Darvas continued to study books and charts, he realized that price movement was not random, in fact once stocks had a defined upward or downward trend, that trend tended to continue for some time.

Within those trends, stocks moved in a series of patterns or what Darvas called “boxes”. This was the beginning of the “Darvas Box Theory” which was to lead him to millions of dollars.

 

“This is how I applied my theory: When the boxes of a stock in

which I was interested stood like a pyramid, on top of each other, and

my stock was in the highest box, I started to watch it. It could bounce

between the top and bottom of the box and I was perfectly satisfied.

Once I had decided on the dimensions of the box, the stock could do what

ever it liked but only within that frame. In fact if it did not bounce up and

down I was worried. No bouncing, no movement meant it was not a lively

 

Darvas bought his shares when prices broke out of the top of the box. While this method greatly improved his entry levels, this system still did not lead to each trade being correct and profitable. At this point Darvas realized that there was no sure thing in the market.

 

He also realized that he could not take chances; he would need to reduce risks as far as possible. With this in mind Darvas decided to employ an automatic stop loss system.

Further reflection led Darvas to re-define his objectives.

  • Right stocks
  • Right time
  • Small losses
  • Big profits

His best weapons were:

  • Price and volume
  • Box theory
  • Automatic buy order
  • Automatic stop-loss sell order.

The World Tour

 At this stage Darvas faced a new dilemma; he signed a two-year contract for a world dancing tour. How could he continue to trade?

Through discussions with his broker, Darvas agreed on one tool.

The broker would airmail the weekly Barron’s financial publication to Darvas. From this Darvas could study prices and follow any rising stocks. Each day the broker would send a cable to Darvas with the open, high, low and close of stocks that Darvas was interested in.

Darvas felt this was like playing poker but he could not hear the betting, he could not see what was going on. However he did hold the cards.

 

Broking Terminology

Automatic buy order:

The way in which an automatic buy order works is quite simple.

In Darvas’ case his entry needed to be at a level when prices burst upwards through the top of a period of consolidation, or the top of the Darvas box. If the top of a box was $35.00, Darvas would give his broker an instruction to buy the stock any time in the future that the stock traded at say $35.25 cents. This order may have been transacted weeks later, if at all. If the price did not continue to advance the purchase was not made. This method ensured that at least at the time of entry, prices were rising.

 

Automatic stop-loss sell order:

At the time of entering a stock, Darvas would place an order to sell if prices traded below a certain level. The advantages of this strategy are enormous; it means that all risk is defined prior to purchasing any stock.

 

The theory starts to work

 

In November 1957 while touring in Saigon, Darvas noticed a stock called Lorillard. There was a bear market at the time but this stock was rising. The stock had risen from $17.00 in the first week of October then consolidated between $24 and $27. Volume had increased from around 10,000 per week to 126,000. Darvas made a series of trades in the stock, finally selling them at $57.50 for a profit of $21,052.95.

This was clearly the turning point for Darvas. Using the same theory he made his first “big kill” on a stock called E.L. Bruce, a profit of over $295,000.

 

In January 1959 Darvas returned to New York with profits totalling more than $500,000.

 

The Second Crisis

Darvas was back in the thick of things, wined and dined by brokers who were amazed at his success, reading everything and listening to hot tips all over again. In the space of a month he lost $100,000 and was devastated by this huge setback. Darvas took a short break in Paris to re-group. Once again the human factor had taken over, logic went out the window and emotions ran high.

 

Emotions and ego need to be strictly controlled in order to achieve success in trading.

 

Making Two Million Dollars

 

In late February 1959, fresh from a trip to Paris, he returned to New York and made a determined effort to re-use the method that had worked so well. He locked himself away, asked his brokers to send him telegrams as they had in the past. The rest as they say, is history. By July 1959 Nicolas Darvas had amassed over two million dollars.

 

Ultimately the story of Darvas success leaked out, he was interviewed by Time Magazine and convinced to write a book that went on to sell over 200,000 copies in eight weeks. I would strongly recommend Darvas’ book “How I Made $2,000,000 In The Stock Market” to anyone trading stocks.