How I Made $2,000,000 in the Stock Market

by Nicolas Darvas

This led me to prefer these stocks more than others, and before I knew what I was doing I had started to keep “pets.” I thought of them as something belonging to me, like members of my family. I praised their virtues day and night. I talked about them as one talks about his children. It did not bother me that no one else could see any special virtue in my pet stocks to distinguish them from any other stocks. This state of mind lasted until I realized that my pet stocks were causing me my heaviest losses.

I should rather hold on to one rising stock for a longer period than juggle with a dozen stocks for a short period at a time.

stocks—like herds, indeed—form groups according to the industry they represent and that stocks belonging to the same industry have the tendency to move together in the market, either up or down.

I figured if I could not make money with the leader, I would certainly not make money with the others.

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.

This experience did more than anything to convince me that the purely technical approach to the market was sound. It meant that if I studied price action and volume, discarding all other factors, I could get positive results.

I figured that if some fundamental change for the better takes place in the life of a company, this soon shows up in the rising price and volume of its stock, because many people are anxious to buy it. If I could train my eyes to spot this upward change in its early stages, as in the case of M & M WOOD WORKING, I could participate in the stock’s rise without knowing the reason for it.

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 the bottom of the box and I was perfectly satisfied. Once I had decided on the dimensions of the box, the stock could do what it liked, but only within that frame. In fact, if it did not bounce up and down inside that box I was worried. No bouncing, no movement, meant it was not a lively stock. And if it were not a lively stock I was not interested in it because that meant it would probably not rise dynamically.

Take a stock which was within the 45/50 box. It could bounce between those figures as often as it liked and I would still consider buying it. If, however, it fell to 44½, I eliminated it as a possibility. Why? Because anything below 45 meant it was falling back into a lower box and this was all wrong—I wanted it only if it was moving into a higher box. I found that a stock sometimes stayed for weeks in one box. I did not care how long it stayed in its box as long as it did—and did not fall below the lower frame figure.

the movement I was constantly watching for was an upward thrust toward the next box. If this occurred I bought the stock. I did not find any fixed rule as to how this takes place. It just has to be observed and instantly acted upon. Some volatile, eager stocks moved into another box within hours. Others took days. If the stock acted right, it started to push from its 45/50 box into another, upper box. Then its movement began to read something like this: 48 - 52 - 50 - 55 - 51 - 50 - 53 - 52 It was now quite clearly establishing itself in its next box—the 50/55 box. Do not misunderstand me on this. These are only examples. What I had to decide was the range of the box. This, of course, varied with different stocks.

The task was to define the frame exactly and be sure the stock did not move decisively below the lower edge of the box. If it did, I sold it at once, because it was not acting right.

Before a dancer leaps into the air he goes into a crouch to set himself for the spring. I found it was the same with stocks. They usually did not suddenly shoot up from 50 to 70. In other words, I considered that a stock in upward trend that reacted to 45 after reaching 50 was like a dancer crouching, ready for the spring-up. Later when I had more experience I also learned that this 45 position in a stock after a 50 high point has another important benefit. It shakes out the weak and frightened stockholders who mistake this reaction for a drop, and enables the stock to advance more rapidly.

The major problem still remained; what was the right time to buy into it? Logically, it was the moment when it entered a new higher box. This seemed quite simple, until the case of LOUISIANA LAND & EXPLORATION proved it was not.

I bought 500 shares of NORTH AMERICAN AVIATION at 94 because I was sure it was about to establish itself in a new box over 100. It did not. Almost immediately it turned around and started to fall back. I could have sold it when it gave up a point. I could have done the same when it lost another point. But I decided against it and stubbornly held on. My pride did not let me act. The prestige of my theory was at stake. I just kept saying this stock cannot go down any further. I did not know what I learned later, that there is no such thing as cannot in the market. Any stock can do anything.

This experience, as I see it, was an important turning point of my stock-market career. It was at this point that I finally realized that: 1. There is no sure thing in the market—I was bound to be wrong half of the time. 2. I must accept this fact and readjust myself accordingly—my pride and ego would have to be subdued. 3. I must become an impartial diagnostician, who does not identify himself with any theory or stock. 4. I cannot merely take chances. First, I have to reduce my risks as far as humanly possible.

I decided to give “on-stop” orders to buy at a certain figure with an automatic “stop-loss” order on them in case the stock went down. This way, I figured, I would never sleep with a loss. If any of my stocks went below the price I thought they should, I would not own them when I went to bed that night. I knew that many times I would be “stopped out” for the sake of a point just to see my stock climb up immediately after. But I realized that this was not so important as stopping the big losses. Besides, I could always buy back the stock—by paying a higher price.

I decided that since I could not train myself not to get scared every time, it was better to adopt another method. This was to hold on to a rising stock but, at the same time, keep raising my stop-loss order parallel with its rise. I would keep it at such a distance that a meaningless swing in the price would not touch it off. If, however, the stock really turned around and began to drop, I would be sold out immediately. This way the market would never be able to get more than a fraction of my profits away.

carried the Broadway comparison through to the problem of selling. I would be a fool to sell a stock as long as it keeps advancing. When to sell then? Why, when the boxes started to go into reverse! When the pyramids started to tumble downwards, that was the time to close the show and sell out. My trailing stop-loss, which I moved up behind the rising price of the stock, should take care of this automatically.

I then sat back and re-defined my objectives in the stock market: 1. Right stocks 2. Right timing 3. Small losses 4. Big profits I examined my weapons: 1. Price and volume 2. Box theory 3. Automatic buy-order 4. Stop-loss sell-order

As to my basic strategy, I decided I would always do this: I would just jog along with an upward trend, trailing my stop-loss insurance behind me. As the trend continued, I would buy more....

knew that I had to adopt a cold, unemotional attitude toward stocks; that I must not fall in love with them when they rose and I must not get angry when they fell; that there are no such animals as good or bad stocks. There are only rising and falling stocks—and I should hold the rising ones and sell those that fall.

knew that to do this I had to achieve something much more difficult than anything before. I had to bring my emotions—fear, hope and greed—under complete control. I had no doubt that this would require a great amount of self-discipline, but I felt like a man who knew a room could be lit up and was fumbling for the switches.

If I was satisfied with what I saw, I cabled to New York my on-stop buy order, which my broker was instructed to consider good-till-cancelled unless otherwise specified. This was always coupled with an automatic stop-loss order in case the stock dropped after I bought it. A typical cable looked like this: “BUY 200 CHRYSLER 67 ON STOP 65 STOPLOSS.”

the inexplicable moves in my stocks usually coincided with some violent move in the general market. As I only received the quotes of my own stocks, I was completely disregarding the possible influence of the general market on them. This was no better than trying to direct a battle by only looking at one section of the battlefield.

I tried to train my emotions. I worked it this way: Whenever I bought a stock, I wrote down my reason for doing so. I did the same when I sold it. Whenever a trade ended with a loss, I wrote down the reason I thought caused it. Then I tried not to repeat the same mistake. This is how one of my tables looked:

I did not like it, but there was nothing I could do. According to my theory, I just had to sit back and wait patiently until one or more of the stocks I had been stopped out of, or any other stocks I was watching, went towards a new higher box.

They say it was merely an intermediate reaction—a temporary halt in the rising market. They all agree, however, that prices collapsed.

Of course all these opinions are expressed by hindsight—when it is too late.

The advice to get out of the market was not available w...

What fascinated me, as Wall Street prices continued to fall, was the gradual realization that my system of ducking out quickly with my stop-losses made such an assessment unnecessary.

I made the joyful discovery that my method had worked much better than I had dreamed. It had automatically released me well before the bad times came. The market had changed—but I was already out of it.

When I looked at this table, I thought this: If my stop-losses had not taken me out of the market I could have lost about 50% of my investment. I would have been like a man in a cage, locked in with my holdings and missing my opportunity to make a fortune. The only way I could have escaped would have been by smashing out, taking a 50% loss, possibly ruining myself, and gravely impairing my confidence for future deals.

I reasoned that if a stock has fallen from 100 to 40, it will almost certainly not climb up to the same high again for a long, long time. It was like an athlete with a badly injured leg who would need a long period of recuperation before he could run and jump again as before. There was no doubt in my mind now that I could not make money by buying a stock and then trying to cheer it on.

So I accepted everything for what it was—not what I wanted it to be. I just stayed on the sidelines and waited for better times to come. I firmly refused to trade—so emphatically that my broker wrote to me and asked the reason. I tried to explain it by making a joke: “This is a market for the birds. I see no reason why I should be in a bird-market.”

As I watched the market continually sinking, I knew that it could not sink forever. Sooner or later stocks would begin to move upwards. They always had. Bear markets were always followed by bull markets. The educated art was to watch for the first signs, be sure they were real, and buy in before everyone else noticed and the prices began to rise too high.

As you see, although I felt quite secure in my judgment with my merged technical and fundamental viewpoints, I did not for one moment consider abandoning my chief defensive weapon—the stop-loss order. No matter how well built your house is, you would not think of forgetting to insure it against fire.