"How I Made $2,000,000 from the Stock Market" is a book on the trading journey of Nicolas Darvas. Nicolas Darvas was a profession...

Three Trading Lessons From "How I Made $2,000,000 from the Stock Market" by Nicolas Darvas

"How I Made $2,000,000 from the Stock Market" is a book on the trading journey of Nicolas Darvas. Nicolas Darvas was a professional trader and he was introduced to stock trading by chance.  he came across stock trading by chance. From then on he was interested in trading and determined to make it work. Not without much hard work and failures including major crisis, he went on to make two million dollars from the market.

In the beginning, he traded based on hunches and tips. With no success with this approach, he studied hard to learn more about stocks and took a fundamental approach to trading. He failed with this approach and failed hard. Out of desperation, he discovered the box theory, a technical approach that gave him some initial success. Subsequently, he added on fundamental reasons for entering a trade and arrived at his techno-fundamentalist theory that eventually allowed him to make massive profit from the stock market.

If you are hoping to get the rules of his techno-fundamentalist theory, I am afraid you will be disappointed. The Box theory was "explained" in about 6 pages of the book and the fundamental aspect is covered in another 4 pages or so. Even with the numerous examples, his entries appeared to be at random points of the Darvas Box though he stated he will enter a trade when price first break above a Darvas Box.

Nonetheless, this is still an excellent read that changed my investment strategy completely. Since young I have been hearing people say "buy low sell high." Initially I was puzzled when I read that Nicholas Darvas was buying at all time high, but soon it occurred to me the benefits of having strong momentum and no overhead resistance made this method perfectly logical.

Three Trading Lessons From "How I Made $2,000,000 from the Stock Market"

1) Importance of Cutting Loss Fast

From the beginning, Nicolas Darvas was able to cut his loss fairly quickly. Even on his first purchase, Eastern Malartic which he bought at 290 cents, he hastily sold it at 241 cents when it was moving down. He did have larger losses for his penny stock trades, but none of them fell by more than 50 per cent. Even on his major trade, Jones & Laughlin, which he refused to sell when it fell, he exited the trade with a less than 20 per cent loss.

Nicolas Darvas have had strings of lost at the beginning of his trading journey. He might not have realised it but his ability to exit a losing trade quickly allowed him to survive through multiple crisis and eventually came up with a winning methodology.

2) Reasoning Does Not Work in the Stock Market

Base on logic, Nicolas Darvas decide to find through fundamental analysis the strongest industry group and the strongest company within that industry group. A perfectly sound strategy.

To find the perfect stock, he compiled earnings of whole industry groups to compare against each other and their past earnings. If that was insufficient, he analysed their profit margins, price earnings ratio and their capitalizations and even their ranking using a reliable monthly service. Eventually, he decided Jones & Laughlin was 'the one'.

With a strong industry group, good rating, low price-earnings ratio, the stock got to go up right? Unfortunately reasoning does not work in the stock market. Within a few short weeks, the stock that 'nothing could go wrong' made Nicolas Darvas take a loss of close to 20%.

The stock market is often irrational and driven by emotions. After conducting throughout research we may be convinced that a stock has to move a particular direction, but the market always has a way for it to move otherwise. As a trader we have to be flexible. If the stock move against us, we need to let go of our reasoning and accept that we are wrong. Yes, fundamentals may prevail eventually, but we may not have the holding power to accept the large drawdown. By accepting that we are wrong and exiting the trade, we may have a chance to re-enter the stock at a better price.

3) More Information may not Lead to Better Decisions

After creating his techno-fundamentalist strategy, he had to go on a dancing tour around the world for two years. During his tour, he can only receive financial information through weekly copies of Barron’s that he will receive four days late, and daily telegrams from his broker. The amount of information on the telegram is limited to a handful of stocks’ high, low and closing prices and the Dow-Jones Industrial Average. This information was sufficient for Nicolas Darvas to make a killing on the market.

An actual telegram Nicolas Darvas received from his broker

When he returned to New York, he decided to bring himself closer to the market, by trading the in the office of one of his brokers. There he had access to live prices, and a stream of facts, opinions and gossip. He became confused and he lost big in those times. It was only when he decided to move away from all the distractions and receive information solely through his telegrams that he became profitable again.

In today’s world, retail traders have access to more tools than what professional traders have during Nicolas Darvas’ time. Today, we no longer need to step inside a broker’s office to obtain information about the stock. With the internet, we can easily get facts, opinions and gossips about any stock from 'experts' all over the world in the comfort of our home or even on the go through our smart phones.

We might be better off reducing the amount of information we receive. By first determining what type of information is required for our strategies before searching for the information required, we reduce our needs to filter off redundant information. If we need to conduct deeper fundamental research, we should look for reputable source to extract the facts. As far as possible, we should avoid being influenced by opinions within articles.

Notable Quotes from the Book

On taking quick profits:
"I did not appreciate it at the time, but it was a classic refutation of: "You cannot go broke taking a profit." Of course you can."

On sudden movement of inactive stocks:
"In the same way, I decided that if a usually inactive stock suddenly became active I would consider this unusual, and if it also advanced in price I would buy it. I would assume that somewhere behind the out-of-the-ordinary movement there was a group who had some good information. By buying the stock I would become their silent partner."

On the movement of rising stocks:
"Stocks did not fly like balloons in any direction. As if attracted by a magnet, they had a defined upward or downward trend, which, once established, tended to continue. Within this trend stocks moved in a series of frames, or what I began to call "boxes"."

On trailing stocks:
"I would just jog along with an upward trend, trailing my stop-loss insurance behind me. As the trend continued, I would buy more. When the trend reversed? I would run like a thief."

On trading what you see:
"As I flew around the world and operated in Wall Street by cables, I slowly came to see that though I was becoming a diagnostician I could not be a prophet."

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