Darvas boxes are dynamic trading range boxes that are based upon a state machine algorithm. Though the calculations very involved, these boxes have two areas. The bottom part is a stop loss area and the top part is the break out area.
When prices break above the top of the box, it’s a buy signal if the instrument was making new 12-month highs on high volume, allowing to stay long and add new positions as new boxes developed. When the price of the stock dipped below the stop loss section of the box (a percentage of the price, just below the bottom of the box), take profits and move on to something else.
In a nutshell one would buy the security when prices broke out of the top of the box on high volume, typically only if the security was making a new 12-month high. If an existing position was held, one would exit the security if the price fell below the stop loss area (the bottom of the box).
Darvas boxes are drawn when certain conditions were met:
The price had reached a new high
- A volume breakout is required for the first box in a series
- The high was followed by 3 consecutive periods that did not trade higher. This formed the top of the box and the first day of the box.
- On or after the high, a low is found that is followed by 3 consecutive periods that did not trade lower. This forms the bottom of the box.
Once a box was constructed, Market entry is made when the price push through the top of the box. Position is held while the price is above the stop level. When subsequent boxes are made, the stop level is set to just below the bottom of the next box. The Darvas box uses several steps to identify a top and bottom, or acceptable trading range. The boxes are used to normalize a trend. A “buy” signal would be indicated when the price of the stock exceeds the top of the box. A “sell” signal would be indicated when the price of the stock falls below the bottom of the box. Darvas’ original interpretation was to only buy when there was a pattern of boxes stacking on top of each other and to place the stop loss at the top of the previous box