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I’d wanted to read this stock market classic for a
long time but it is notoriously hard to find. Finally I bought it through a
reseller on Amazon.com. The seller was in England and the book arrived in my
mailbox a couple of weeks later. It was worth the wait!
What adds to the book’s appeal is that, unlike Jesse
Livermore, Darvas was not a professional investor. He was a professional
dancer. He and his dance partner Julia entertained at nightclubs around the
world. And because he was not a professional, he got his chops in the school
of hard knocks. He learned by doing. And he chronicles his progress, all the
mistakes he made along the way, where his thinking went wrong, and how he
eventually developed his own theory which made him $2 million in 18 months,
starting with a stake of less than $25,000.
Darvas got involved in the stock market quite by
accident. In 1952 he was offered a dancing gig in Toronto. The twin
brothers who owned the club, Al and Harry Smith, made Darvas an unusual
offer. They wanted to pay him in shares of a Canadian junior mining company
called Brilund. It was trading at 50 cents a share – 6000 shares worth $3000
for his appearance. Darvas was a bit skeptical as he knew stocks went up and
down in price. The Smiths agreed to make up the difference in cash if the
stock dropped below 50 cents for the six months following the deal. Darvas
agreed.
As it turns out, Darvas could not keep his playdate
and felt badly about letting the brothers down. So he offered to buy the 6000
shares for $3000. He got the shares and forgot about them until he noticed
two months later that the stock was up to $1.90. He sold and made an $8000
profit. His appetite, as they say, was whetted.
Then began the education. He thought Canadian penny
mining stocks were the cat’s meow. “I jumped in and out of the market like a
grasshopper,” he writes. He became enamored of some, calling them his
“pets”. And he started losing money. So he quit the Canadian market and
opened an account with a broker on Wall Street.
His education continued. He followed broker tips. He
subscribed to newsletters. He read books. He tried fundamental analysis. And
he over-traded like crazy. When Rayonier went from $50 to $100, he was in and
out three times picking up $5 here, $8 there and $2 in his last trade. He
made $13 a share on Rayonier instead of $50.
When he found out about industry groups, he decided
buying the strongest stock in the strongest industry was a good idea. He was
so convinced he was on to a sure thing he mortgaged some property he owned in
Las Vegas, borrowed on an insurance policy and plunked down $50,000 on steel
company Jones & McLaughlin using margin. Three days later “lightning struck.
Jones & McLaughlin began to drop.” He was stunned. He held on believing it to
be a temporary setback. He became afraid. “I trembled when I telephoned my
broker,” he writes. “I was scared when I opened the newspaper. I literally
lived with my stock. I was watching it the way an anxious parent watches over
his new-born child.”
As you can tell, Darvas is a compelling writer. He
grabs the reader’s attention. We’ve all been there, done that. We know what
he’s talking about!
But Darvas didn’t give up. And he went on to develop
his own method of investing, a largely technical approach. He calls it the
box theory and it works like this. He noticed that stocks fluctuate and
stocks in an upwards trend will often pause and take a breather, fluctuating
within a range. A box he called it. And he noticed that when the stock broke
out of this box to the upside, it tended to go up further. And if it broke
out to the downside, the trend was often broken.
For example, if a stock was fluctuating between 45
and 50 dollars – a 45/50 box, if it broke through to 51, it would likely go
higher. If it broke through to 44, it would likely go lower. So he would buy
at 51 and set a stop loss for the top of the last box or 50. Darvas used very
tight stops on his initial purchases. He reasoned that the stock had broken
out of the box and it had no business going back in the box. If it did, then
he made a mistake and wanted to get out as quickly as possible with as
little damage as possible. He also looked to increased volume as a positive
indicator.
He was not averse to playing the same stock several
times. For example, he played steel company Cooper-Bessemer three times
between November 1956 and April 1957. Bought at 46, stopped out at 45 1/8;
bought at 55 3/8, stopped out at 54; bought at 57 and sold for a hefty profit
at 70 ¾. Two losses and a victory for an overall gain of over $1500. In the
fall of 1957, a bear market developed but he had been stopped out of all his
positions well ahead of it. His system had put him in cash when the market
went south.
Darvas was fascinated that he didn’t have to have
theories or predictions about where the market in general was headed. The
individual stocks told him the story by their behavior. And he learned you
can’t get emotional about the market. “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.”
It was during this mini-bear that he made an
important discovery. He read the stock reports daily. He noticed some stocks
gave ground grudgingly, fighting the down trend. Checking these stocks
further, he discovered they were growing earnings. “Capital was flowing into
these stocks, even in a bad market. This capital was following earning
improvements as a dog follows a scent.”
And so he married this fundamental idea to his
technical box theory. “I would select stocks on their technical action in the
market, but I would only buy them when I could give improving earning power
as my fundamental reason for doing so.”
And he decided to focus on “those stocks that were
tied up with the future and where I could expect revolutionary new products
would sharply improve the company’s earnings.” Yes, he became a tech stock
investor…way back in the 1950s. “They were rapidly-expanding, infant
industries and, unless something unforeseen happened, their expansion should
soon be reflected in the market.”
You may notice some striking similarities to Jesse
Livermore’s approach. Others were the idea of probing the market, that is
buying a bit now, a bit more on confirmation and still more after that. In
fact, like Livermore, Darvas was a plunger. He bought few stocks. After he
made a million, he re-invested the proceeds in just two stocks!
Darvas’s book is a fascinating read. It’s almost as
valuable for the discussion of the mistakes he made as for his successes. And
it reads like an adventure story, a compelling page turner. Get it! You won’t
be disappointed.
Marco den Ouden
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