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Of the many books written about trading, few are worth the paper they are written on. How I Made $2m In The Stock Market is different, it is one of the few gems worth reading over and over.

Like other great books on investing and trading, it has withstood the passing years of rallies and crashes and is as useful today as it was in the nifty fifties.

Darvas was no trading pro or theoretician; he developed his method using his own money in a primitive trading environment almost unimaginable today in our world of complex tools and voluminous data. In fact the general naiveté of the book underscores the robustness of his method.

Most so called trading rules can’t and don’t work because it would mean that the participants of the trading world could all make huge profits and take their gains from the market. In such an environment the system would be drained of cash and it would implode. It is this obvious insight that underlines the fact that trading is not a science but an art.

While the Darvas system is simple, it still requires judgement, yet it is still clear how to apply its rules.

Most trading rules appear to work because they rely on ‘observer bias’ – a trick of the mind that highlights the system working, while hiding when the system fails. Support and resistance is a classic example, where only the support or resistance that works is recalled, while the many others are overlooked.

The Darvas system, however, works without much subjectivity and its application can be seen today in current scenarios in the same way as when he wrote the book.

Darvas was a dancer, travelling the world putting on ballroom exhibitions, meanwhile awaiting telegrams that kept him posted about the progress of his positions in New York. There was no need for him to have the up to the minute news or price, not that they were available in those days.

That in itself is an important lesson. Medium term trading is more likely to be profitable than short term day trading. This is confirmed today by spread betting companies who say that their best winners take medium term positions. The medium term investment stance is not only benign, but also convenient, in that most readers will have a job and watching the markets is not conducive to keeping one.

The starting point for Darvas was to look for insider trading. He did this by watching out for sudden increases in trading volume, which he took to be a strong sign that something was afoot with the company. After taking a position he would then see if a rise confirmed this suspicion and then increase his position.

The key stock behaviour he watched for occurred when the stock had finished a rally and began to trade sideways. This sideways trading pattern then formed a range he called a box, the edges of which determined whether he would sell or buy. Breaking out of the box upwards would trigger a buy and conversely breaking down would trigger a sell.

This simplicity of the system was its strength. But of course it has flaws.

No system can be foolproof, but making losses while making bigger profits is not a flaw, simply a reflection that a system is effectively blind to the realities behind the market move, but has an ability to be more right than wrong guessing its direction.

The flaw to the Darvas system is that it relies on overall market conditions.

Darvas was operating in a boom market, much like the dotcom boom of the 90s, and many of the charts illustrating the book look exactly like the booming technology companies of that recent bubble. Darvas would have made many more millions with his system in the dotcom boom environment.

The system requires a market with explosive upside which triggers startling rallies and it would be of little use in quiet markets which rarely produce massive share price spikes like the ones he enjoyed.

However, to say that the system is not a method for all seasons is no real loss, it is very good for the sort of share that can go up two, three, five, even ten-fold, it’s just a matter of finding the right arena or waiting for the right time to come by. It always does.

Happily these days – unlike for Darvas who did not reproduce his success in the 60s – there is always something in the market that is the next Big Thing and as such his system is of practical use in these hot sectors. The volatile world of currencies, commodities and wide ranging stock sectors generally ensures that the Darvas method can be brought to bear on a selection of instruments at one time.

The recent commodity rally is a fine example, as was the net gambling stock boom of 2005. The next sexy sector is bound to rear its head soon and when the stocks in that group begin to shoot up, the Darvas system will be just as useful today as it was in the fifties.

For most investors getting out with a profit is the hardest thing, because the share has probably beaten all expectations and seems capable of anything. The emotionally attached investor is loath to betray this profitable allegiance and is then caught by the slump. The system in this book gives an investor a simple way to set his stop losses and get out with his handsome profit and this alone is a priceless tool.

The Darvas boxes are, in reality, equilibrium points that mark the short term end point of a revaluation of a share. These points rarely hold and are revised either upwards or downwards. His method takes advantage of this and gives the investor a simple way of balancing greed and fear. In the modern world however, stop losses can be dangerous and while Darvas picked round numbers for his stop losses, you would do well to set them a safe distance from the obvious levels other traders may seek to exploit.

How I Made $2m In The Stock Market is a rare book and as such is a precious one. Few people know of it and few people use this technique for riding exploding stocks and for getting out of them near the very top of their runs. As such, until the day this system is popular it is likely to be a very useful and profitable one.

Clem Chambers,

Managing Director, ADVFN