The Gambler

The author, Nicolas Darvas, was a professional dancer. In 1952, he was proposed to dance in a
Toronto nightclub for which the payment was to be made in the form of stocks of Brilund company
in the Canadian stock market. Unable to perform, he still offered to buy 6000 shares of the company
at 50 cents as a gesture. He forgot about those shares and after two months, when he checked, he
was surprised to see the stock price at $1.9. He made a profit of approx $8000 unintentionally and
that’s how his journey in the stock market commenced.

Impressed by this profit; he decided to invest more in the Canadian stock market. Being a novice in
the stock market, he started taking advice from every second person, about which stock to invest in.
But what came next was a period of absolute failure. He kept hopping in and out of 25 to 30 stocks.
Even when he made profits, he incurred an overall loss because of the brokerage charges he didn’t
account for .

Thereafter, he decided to seek help from financial advisors and his brokers. Many times he did get
lucky but by the end of 1953, his $11000 was down to $5800. He then moved to New York and
started looking over the New York stock exchange. This made him gain interest in Wall Street and he
decided to sell all his stocks in the Canadian stock market.

The Fundamentalist
Nicolas opened an account with a brokerage firm and started with $15,800 to trade on Wall Street.
Initially, the market was on a bull run and everything went well. However, it slowed down later .

He was not bothered by the occasional setbacks. However, he praised himself for a successful trade
and blamed the broker for an unsuccessful one.

He realized that no matter how big or small his profits and losses were, the broker always made
money. He understood that even the advisors were not giving a perfect stock to make money. He
was selling a few stocks too quickly to make small profits. His profits and losses were offsetting each
other.

He then entered the over-the-counter market (the market of unlisted securities) and bought stocks
of around 6-7 companies. In such a market, the stock prices change according to the bid and ask
prices. Whenever he wanted to sell his stocks he found it hard to find a buyer. And when he did, the
deal would end up in a loss. Consequently, he returned to the listed securities.

Through his experience, he learnt the following lessons :

1. It's better not to follow The tips from the advisory service as they are not perfect. The vast
majority of advisory services are dangerous if they do not set risk criteria for their
subscribers. Most of these are written by people who make money on the letters not
trading.
2. It is always better to trade a historically proven system because brokers can also be wrong.
Each trade should make sense and fit inside your trading plan.
3. In trading you have to let your winners run and cut your losses short. If you cut your winners
short by taking $100 profits twice and let your losers run and then lose $200 two times you
are down $2000 after ten trades. That is a great procedure for going broke over a long
period.
4. Trade in listed stocks only and keep a healthy volume of over 500,000 shares a day. Never
trade in the “over-the-counter” market and penny stocks. There is very little regulation in
the over-the-counter market and it is very dangerous to buy a stock that could have no
possible buyer when you are ready to sell.
5. Do not listen to rumours because they are false most of the time and add no value to
trading. Nicolas Darvas did not trade rumours, he traded price action.
6. Instead of gambling, one should study the market. Companies with innovative products and
real earnings are the ones that go up in value. A few junk stocks may rise for a period based
on anticipated game-changing information but they usually sink back to their original prices.
7. Trading will be much better if the focus is on a limited amount of best stocks rather than
holding a dozen stocks for a shorter period. Buy the good stocks when they are at their
strongest and breaking out of key resistance points.

During the same period, the author developed his fundamental approach to analyzing stocks. In
this approach, he considered the earnings, dividend history and other reports of the company.
One of his stocks, Virginian Railway, gave him a profit of $1303. With the help of his broker, he
decided to find out the reason behind its good performance. Thereupon, he realized that the
company had a fine earnings record and paid a good dividend. Its monetary position was
impressive. The reason behind the company's rise was its fundamentals which made him more
confident about this approach. Thereafter, he started studying the company profiles and their
reports but still, the stocks he chose were not enacting as per the analysis .

My First Crisis
In this chapter of the book, the author tried to find out the following through fundamental
analysis –

 The strongest industry

 The strongest company within that industry.

Whenever a stock started to act better than the market he immediately looked at the behaviour
of the other stocks of the same industry. If those too behaved well, he looked for the leader- the
stock that was acting best. He reasoned if he could not make money with the leader, he would
certainly not make money with the others.

He started compiling earnings of whole industry groups like oil, steel, motor and aircraft. He
compared their earnings and carefully evaluated their profit margins, the price-earnings ratios
and their capitalizations.
Finally, after an enormous amount of concentration, he determined that the steel industry was
the vehicle, which would make him rich.

Based on this judgement, he selected JONES & LAUGHLIN at 52.25 on margin, which was 70% at
that time. On the 23rd of September 1955, he bought 1,000 shares for $52,652.30 and he had to
deposit $36,856.61 in cash. To raise this amount he kept all his assets as a guarantee. According
to his most scientific and detailed research, he was sure nothing could go wrong.

On October 10th, the stock dropped to $44, and he sold his stocks with a net loss of $9069.18.
He was discontented because it was not a gamble but a scientifically selected stock. He
continued because he had to save his property.

Based on further analyzing the stock tables he noticed Texas Gulf Producing was rising, a stock
he never heard of. He knew nothing about the company’s fundamentals but still went for it only
to recover more than half of the loss he made from Jones and Laughlin. This gave birth to his
new theory known as “The Box Theory”. In the next chapter the author speaks about his Box
Theory.

The Technician
The author realized that making a profit in the stock market isn't a matter of luck. One can be
lucky once or twice but not consistently.

He then bought stocks of M&M Wood Working on the same principles as Texas Gulf Producing.
He did not know much about it but assumed from its continuous rising and high volume that
some people knew a lot more about it. He made a profit in the stock.

Later he bought 200 shares of Pittsburgh Metallurgical and incurred a loss of $2023. After an
extensive analysis, he found that he had bought the stock at the top of an 18-point rise. It was
the right stock bought at the wrong time.

He learned that stocks do not move haphazardly. Their movement is determined by an upper
and lower limit. These limits act as a perimeter which the author called “boxes”. The stock price
oscillates in these boxes. This was the inception of his Box Theory.

He then used his theory on 3 stocks to make a profit but suffered a significant loss in the 4th
one, which took him back to where he had started. This experience taught him the following
lessons–

 There are no sure things in trading. Anything can happen in the stock market. Even the
best traders have about a 50% win rate in their trading.
 A trader's goal is not to be right every time. It is to lose little when wrong and win big
when right. The main goal is to make money and not prove anything to anyone. Hence,
there is no place for pride and ego.
 It is better not to stick to any theory. The actual price action should be traded, not the
personal opinions about where the market ‘should’ be going.
  Reduce the risks as far as possible. The key to successful trading is to maximize profits
and minimize risks. A big risk for little profit is dangerous and eventually tends to blow
up the account.

The author started including stop loss in his orders so that just when the stock falls below the
expected price, he would not own them.

He defined his goals in the market as follows:

1. Right stocks
2. Right timing
3. Small losses
4. Big profits

To realize these goals, he had the subsequent tools:

1. Price and Volume

2. Box theory
3. Automatic buy-order
4. Stop-loss sell-order

Cables Round The World

In this chapter, Darvas talked about the time of his life when he signed up for a 2-year tour all
around the world. He was apprehensive about operating from other countries. Thus he and his
broker chose to stay in touch via cables (a method of communication at that time) and used
Barton’s financial journal to look for stocks.

He began giving instructions to his broker over cables. His cables from the broker had the closing
price, the box which comprised the upper and lowest ranges throughout the day, and the
general market trend. Whenever he suffered a loss he wrote the reason for it and decided to
never repeat the mistake. After some time, he started getting sold out of all the stocks he owned
because of the stop loss. He could not figure it out at first but later when it was declared a bear
market.

With the help of his theory He was able to come out of the stocks without incurring a huge loss
and this gave him great confidence because his theory worked. He was on his own without any
news and still, he was able to get out of the market on time.

The Techno-Fundamentalist
Nicholas Darvas put up with the market for what it was and realized that he could not do
anything but wait for better times to come. However, during this time he constantly kept his
eyes on the stocks.

He selected stocks based on his technical theory but only bought them if their fundamentals
were right. This is how he reached his techno-fundamentalist theory.
He knew that he had to find companies that were coming up with something big. For example,
automobile giants were once small companies and people who invested in them then made a lot
of money. Hence, he decided to find small companies that had a bright future in the coming
months or years. These were high velocity, expensive-but-cheap stocks, which means their
prices were high but valuations were cheap.

He was now placed with 5 years of experience with lessons he got from his journey –

 The Canadian period trained him not to gamble.

 The Fundamentalist period taught him about industries, dividends, earnings, etc.
 The Technical period taught him how to analyze the price movement of the stocks.

The Theory Starts To Work

Now, the techno- fundamentalist theory has started to work. In November 1957, Darvas noticed
a stock- Lorillard. The stock fit his theory. Its volume for that week had increased sharply from an
average of 10000 shares to 126700 shares. The constant rise in price and volume indicated the
incredible interest in that stock.

He bought the shares at the following rates –

S. No. No. Of Shares Unit Price ($) Total Amount ($)

1 200 28.75 5,808.76

2 200 35 7,065.00
3 200 36.5 7,366.50
4 400 38.65 15,587.24
Total = 1000 35,827.50

Then he bought Diner’s club –

S. No. No. Of Shares Unit Price ($) Total Amount ($)

1 500 24.5 12,353.15

2 500 26.15 13,167.65
Total 1000 25,520.80

He got out of the Diner’s club because it fell below the stop loss. His theory worked and he
received $35,848.85, making an overall profit of $10,328.05. He was able to book profit just
based on cables and Barton’s.

Next he noticed that the stock EL Bruce meets his theory. He chose to sell Lorillard and invest
the money in EL Bruce. He sold all of the 1000 shares at an average price of 57⅜ making a profit
of $21,052.95.
He bought EL Bruce at the following prices –

S. No. No. Of Shares Unit Price ($) Total Amount ($)

1 500 50.75 25,510.95

2 500 51.15 25,698.90
3 500 51.75 26,012.20
4 500 52.75 26,513.45
5 500 53.65 26,952.05
Total 2500 130,687.55

He was suggested to sell these shares at a $100 unit price but he didn’t because according to his
theory, the stock still showed indications of growth. He gradually sold his stocks in blocks of 100-
200 shares at an average price of $171. He made a $295,305.45 profit on this stock.