The “Box Theory” is a technical analysis method that uses price highs and lows and trading volume to identify entry, exit, and stop-loss points.
1. What is the “Box Theory”?
Box Theory (Darvas Box Theory, also known as “Box Theory” or “Box Consolidation”) utilizes the situation when both buyers and sellers in the market are evenly matched.
When the stock/coin price is stuck in sideways movement, if the price drops to a relatively low point, there will be buying pressure to provide “support”;
When the price rises to a relatively high point, there will be selling pressure,
At this time, both sides are at a stalemate, and the stock price will oscillate back and forth between support (the bottom of the box) and pressure (the top of the box), forming a “stock box”.
When the stock/coin price breaks through the pressure (the top of the box), which is commonly referred to as an “upward breakout,” the original pressure (the top of the box) will turn into new support (the bottom of the box), forming another new “stock box” at a higher price level.
An upward breakout is an important signal for bulls and will attract more buying pressure to push the stock price up. Therefore, buying when the price breaks through the top of the box is equivalent to buying at the new bottom of the box, allowing one to profit from the rising stock price through the stacked boxes.
However, when the stock/coin price breaks below the support (the bottom of the box), the original support (the bottom of the box) will turn into new pressure (the top of the box), forming another new stock box at a lower price level, which brings more selling pressure and causes the stock price to continuously decline. At this time, it is necessary to stop losses in a timely manner to avoid greater losses.
2. How to draw a box?
The width (time length) and height (price fluctuation range) of the stock box can vary according to the trading (investment) strategy, whether it is long-term or short-term. Generally speaking, the longer the stock box lasts, the higher its reference value; the shorter the stock box, the lower its reference value and it tends to be more speculative in nature.
When the stock price breaks through the original top of the box, accompanied by an unusual increase in trading volume, it indicates that a new “stock box” at a higher price is about to appear.
Where is the top position of the new stock box? You can observe when the stock price reaches a new high (Point A) and is accompanied by three consecutive candlesticks that do not exceed Point A to confirm the position of the new top of the box.
After confirming the top position at Point A, if the stock price oscillates back down to a low point (Point B) and is accompanied by three candlesticks that do not fall below Point B, you can confirm the lowest point B as the position of the new bottom of the box.
3. The way the box moves
When the overall trend of the stock price is upward, it will continuously create higher-priced stock boxes, stacking one on top of another. According to box theory, when the stock price breaks through the top of the box, it is the time to buy, and when the stock price breaks below the bottom of the box, it indicates insufficient support and is likely to enter another lower-priced stock box, thus the bottom of the box is the stop-loss point.
As the stock boxes stack upward, there is no need to rush to sell holdings to take profits, as it is very likely that the stock price will continue to rise. You can also adjust your position and stop loss based on the price position of the new stock box. When the new stock box breaks upward again, you can add to your position and set the new bottom of the box as your new stop-loss point.
4. Buying and selling according to box theory
Box theory is a strategy for going long. Its significance lies in providing a basis for entry and stop-loss based on market price patterns.
Let’s review some important characteristics observed by Darvas regarding the box:
1. When a stock's price reaches a 52-week high, it may form a pressure line (top of the box) at certain points, and the price may also encounter buying power, forming a support line (bottom of the box). When the pressure line and support line repeatedly occur, a box will form.
2. When the box ends, the stock price usually breaks through the upper or lower edge of the box with a strong trend and larger trading volume, followed by a higher probability of a clear upward or downward trend.
3. A box may only represent high and low points within a few days, but the longer the time range of the box, the more reference value it has, indicating a higher possibility of a trend emerging afterward. Conversely, shorter box ranges tend to be more speculative. Sometimes a box may be broken through quickly, while other times it may last a long time.
4. If a box ends and breaks upward, it is likely to enter another box range.
Upward breakout vs downward breakdown
Upward breakout (entry point): If the stock price breaks through the pressure line (top of the box), it is an upward breakout, and some will enter at this time. Generally, the entry point is set at the upper edge of the box.
Downward breakdown (exit point): If the stock price breaks below the support line (bottom of the box), it is a downward breakdown, and if one has already entered, then one should exit and stop loss to avoid further losses. The stop-loss exit point is set at the lower edge of the box; the maximum loss per trade is controlled within the range between the upper and lower edges. If the range of the box is too large, the exit may be set in the middle of the box, which does not have an absolute standard.
Typically, within the frame of the box, you will see lower trading volume, indicating fewer transactions back and forth between buyers and sellers. Therefore, trading volume is also a key indicator for upward breakouts and downward breakdowns.
When a breakout occurs, trading volume often increases, indicating differing opinions between buyers and sellers, with one side ultimately prevailing.
5. Trading methods according to box theory
1. Find trading targets: The type of target should have a certain scale, not too small or with no trading volume, and have long-term growth momentum and an upward trend.
2. Find the box range: In an upward trend, look for the characteristics of box consolidation, within a certain period some highs and lows are difficult to break through.
3. Set the buy and stop-loss points: When the box forms, you can set the buy point slightly above the top of the box and the stop-loss point below the bottom of the box.
4. Wait to buy: Once the upper edge of the box breaks through, it triggers a buy.
5. Stop-loss: After an upward breakout, sometimes the price does not continue to rise, but may consolidate or reverse downward. If the price breaks below the original lower edge of the box, then exit and stop loss. You can control the loss within the range of a box’s height.
6. Add positions: After the price rises, it is likely to enter the next box, and you can similarly set the buy point for adding positions at the upper edge of the new box, adding positions when it breaks through.
7. Exit: When the price rises and enters the next box, the exit point can be moved from the lower edge of the original box up to the lower edge of the new box, similar to the concept of moving stop-loss for profit.
6. Five key techniques of box theory
(1) Box theory is more suitable for use in bullish markets.
(2) Combine with fundamental analysis to select industry-leading stocks with good financial performance.
(3) First observe the trends of one or two stock boxes before deciding on an investment strategy; do not take risks by acting rashly in the first stock box.
(4) Upward breakouts need to have strong trading volume as support; otherwise, it is better to observe more.
(5) As long as the stock price does not fall below the bottom of the previous stock box, do not stop loss to avoid missing out on continued profits.
7. Points to note when using box theory for trading
Here are several matters and suggestions to pay attention to when trading with box theory:
1. It is recommended to invest in high volume targets: Basically, this type of technical analysis does not work on obscure stocks. After all, in obscure stocks or small-cap stocks, the main players can draw lines themselves.
2. Box theory must be used in at least a mid-term upward trend; currently, there is no evidence that it is useful in a downward trend.
3. For short-term analysis, it is recommended to use candlestick charts rather than line charts, because candlestick charts will present opening, high, low, and closing prices, including the highest and lowest prices, which represent the true range of the box. However, line charts only show the closing price connections. A daily chart is sufficient for the cycle; in Darvas's era, there were only daily charts, not real-time intraday charts.
4. The upper and lower edges do not have absolute precise numbers; they are not a single point, but rather a rough range. For example, you can allow a 0.3% error range to reduce the issue of being washed out by false breakouts. Darvas would confirm with trading volume.
5. The narrower the box range, the better for investors, as it allows for a smaller stop-loss range.
6. The longer the box lasts, the more reference value it has, indicating that the upper and lower edges of this box are more worth referencing.
7. An upward trend's boxes will appear in a stepped pattern: Darvas mentioned in his book that he believed multiple boxes would continuously appear in an upward trend, resembling a staircase. If this happens, it indicates that you are doing it right.
Conclusion
Box theory is an investment philosophy summarized and organized by Nicolas Darvas, who invested in the U.S. stock market during a great bull market. Although box theory has stood the test of time and remains applicable in most situations, it should be noted that it is more suitable for application in rising stocks, as well as stocks that are not small or easily manipulated.
(How I made $2 million in the stock market) is the author's investment memoir, which does not involve complex theoretical analysis but narrates the author's journey in investing in the stock market. The reason it is worth reading is that, while observing the author's story, one can also see their own investment process, such as past novice mistakes, anxiety over losses, and how to bounce back, providing readers with a strong sense of resonance. The author also repeatedly emphasizes that to make a profit in the stock market, the most important thing is to adhere to one's investment principles.