Search only for the very best opportunities

THURSDAY, MAY 01, 2008

Trading Lessons From Nicolas Darvas
Nicolas Darvas has inspired traders for many generations. His book, "How I Made 2,000,000 in the Stock Market" is one that you'll find on many recommended reading lists including my own. While some have argued that much of Darvas' success had to do with good timing, his books are still widely read and for good reason.
A lot of traders can identify easily with Darvas because he went through the process of learning how to trade much like most people do today. Darvas began by first looking for the "secret" to the market. And, just like all of us have found, after finding no success from trading on the stock tips of others including brokers and expensive newsletters, Darvas figured out that he ultimately had to develop a trading system on his own. He accomplished that feat by committing himself to years of study of the market and from learning from his own mistakes. His determination, perseverance, and constant self-evaluation offers an excellent model for all traders to follow.

In continuing a series of posts where I share my notes I've taken (and refer to from time to time) after reading the books and methods of others, here are some things you may find of interest about Nicolas Darvas and his approach:

Trading Lessons From Nicolas Darvas:
There are no good or bad stocks. There are only stocks that rise in price and stocks that decline in price, and that price is based on the laws of supply and demand in the marketplace

"You can never go broke taking a profit" is bad advice that will result in overtrading and cutting winners short. Selling winners and holding losers is to be avoided at all times

There is a "follow-the-leader" style in the market. You will find success by selecting the most active and strongest industry group and trading its top leader

The combination of price and increased volume is key to stock selection. Focus your time on new leaders emerging with a new market cycle

It is the anticipation of growth rather than the growth itself that leads to great profits in growth stocks. "You have to find out what the public wants and go along with it. You can't fight the tape, or the public."

One of the quickest ways to lose money in the market is to listen to others and all of their so-called expert opinions. To succeed, you must ignore all outside opinions and predictions. Follow your own strategy!

Losses are tuition on Wall Street. Learn from them.

You should expect to be wrong half of the time. Your goal is to lose as little as possible when you are. "I have no ego in the stock market. If I make a mistake I admit it immediately and get out fast. If you could play roulette with the assurance that whenever you bet $100 you could get out for $98 if you lost your bet, wouldn't you call that good odds?"

Most of your big failures will come from three things: 1) when you abandon your rules, 2) you become overconfident, and 3) trade in despair when unsuccessful

The best speculators search only for the very best opportunities. To be truly successful, you must wait for the right opportunities to present themselves and this often means doing nothing for long periods of time

The market behaves the way it does due to participants behaving the way they do. No one knows what they will do until they actually do it

Long-term investors are the real gamblers in the market due to their eternal hope that losing stocks will come back in price

It is difficult to be profitable on the short side of the market versus the long side - trading in rising or bull markets will give you the best chance for success

Most, if not all stocks, will follow the general trend of the market

To train your emotions, write down the reasons for making every trade. When you lose, write down what you thought contributed to the loss. Then study and set new rules to avoid making those same mistakes

Concentrate your trades. At the peak of his success, Darvas would hold only 5 to 8 stocks at one time which was in contrast to his earlier days when he was overtrading and would hold up to 30 stocks at a time

Avoid fallen leaders. Overhead resistance will keep upside potential limited due to supply from previous buyers who had not cut short their losses. According to Darvas, the only sound reason for a stock is one that is rising in price. If that is not happening, then there is "no other reason worth considering."

Darvas used his "box theory" to trade using boxes to time his entries (on breaking out to a new higher box) and exits (breaking below the current trading box). For more info on using Darvas boxes, visit these two websites: GerryCo & Sethi

For new trades, Darvas used "pilot buys" which basically were starter positions in stocks he liked. Only if the stock continued to move higher would he then pyramid and increase his position. He learned never to buy more of a losing position

He thought many unsuccessful investors made the mistake of looking at the same familiar names that might have worked well for them in the past instead of focusing on the next stock with the right elements for the new market cycle. "I am only in infant industries where earnings could double or triple. The biggest factor in stock prices is the lure of future earnings. The dream of the future is what excites people, not the reality."

Perfection has no role in successful trading. No one can buy at the absolute lowest price and sell at the highest price. No time or effort should be devoted to that goal. "I never bought a stock at the low or sold one at the high in my life. I am satisfied to be along for most of the ride."

Trade only when the environment is in your favor. Darvas' strategy kept him out of poor and bear markets because he wouldn't trade stocks that didn't fit his requirements which were only found in raging bull markets

Be aggressive when warranted. Darvas believed in making aggressive trades when his system pointed to a great trade. In fact, sometimes 50% of his capital was devoted to just one stock

While his trading approach was very technical, after studying the market's winners he understood the relevance of finding stocks also with good fundamentals. Namely, Darvas thought that earnings and the future estimate of increased earnings were very important

Be a student of the market. Darvas learned by reading more than 200 books about speculators and the market and devoted studying the market for many hours a day. In fact, Gerald Loeb's books & approach served as key inspiration

No one can completely master the market. After millions of dollars and best selling books, Darvas was still learning and tweaking his system until he passed away