Chapter 7. The Theory Starts to Work

While most Wall Street stocks drifted or dropped, I continued my dancing tour of the world. In November 1957 I was appearing at the "Arc En Ciel" in Saigon when I noticed in Barron's a stock unknown to me called LORILLARD.

I did not know then that they were the manufacturers of a particular brand of filter-tip cigarettes and the filter-tip craze was about to sweep America, causing their production to leap up astronomically. Out in Saigon, all I knew was that lorillard began to emerge from the swamp of sinking stocks like a beacon. In spite of the bad market, it rose from 17 until, in the first week of October; it established itself in the narrow box   24/27  . Its volume for that week was 126,700 shares, which sharply contrasted with its usual 10,000 shares earlier in the year.

The steady rise in price and the high volume indicated to me that there was a tremendous interest in this stock. As for its fundamentals, I was satisfied as soon as I found out about the wide acceptance of their "Kent" and "Old Gold" cigarettes. I decided that if it showed signs of going above 27 I would buy it.

I asked my broker to cable me daily quotes. It soon became clear from these quotes that certain knowledgeable people were trying to get into this stock in spite of the general state of the market. Few people at that time had the faintest indication that lorillard was to make Wall Street history, that it was to shoot up to a most astounding high in a relatively short time, watched by the amazed and gasping financial community.

We were at the depth of the baby-bear market and the at­mosphere was rather gloomy. But, as if unperturbed by the gen­eral pessimism, lorillard was happily jumping up and down in its little cage.

By mid-November 1957 it became even more independent and it began to push upward toward what I estimated would be a 27/32 box. This isolated strength in the face of general weakness was very impressive to me. I felt I had sufficient proof of its strength, and I decided to become a bull in a bear market. I sent the following cable from Bangkok:

"BUY 200 LORILLARD 27½ ON STOP WITH 26 STOPLOSS"

As you see, although I felt quite secure in my judgment with my merged technical and fundamental viewpoints, I did not for one moment consider abandoning my chief defensive weapon—the stop-loss order. No matter how well built your house is, you would not think of forgetting to insure it against fire.

Within a few days, I received confirmation that I had bought 200 lorillard at 27½. I was well satisfied with my purchase, and braced myself for a big rise.

This came, but not the way I had assessed it. My first experi­ence was disheartening. On Tuesday, November 26th, the stock dropped back exactly to my stop-loss of 26 and I was sold out. To add insult to injury, seconds after I was stopped out, it started to rise and closed at 26¾.

However, the reaction was so short and the rise that followed so firm, that I decided to go back into it. That same week I bought back my shares at 28¾. Again I fixed my stop-loss at 26.

But this time, lorillard's behavior was perfect. As the days went by, I was satisfied to see that the quotations never came close to my stop-loss. This was a firm indication that I was on the right track, and that my theory applied to this stock.

I happened to be right. In December 1957, lorillard rose over 30 and made a new 31/35 box. My experiences with similar stock movements in the past told me that it was being accumulated. I felt I had the right stock. Now it was a question of getting into it with more money at the right time.

I carefully watched my daily quotes. I looked for the right moment as a fighter looks for an opening to land his blow. Towards the end of January, after a false move, the big surge-through which I had been expecting occurred, lorillard started to move decisively out of its box.

This seemed to be the ideal moment. Everything was en­couraging—the technical action, the fundamentals, the pattern. Also, the New York Stock Exchange had just lowered its margin requirements from 70% to 50%. This meant that my limited capital now had much more purchasing power. Every $1,000 could buy $2,000 worth of stock. This was important to me, because I needed my funds for another stock I was watching at that time.

I was flying from Bangkok to Japan. It was from there I sent out my cables to add a further 400 shares to my holdings. These were bought for me at 35 and 36½.

In the weeks that followed, the stock's behavior continued to be exemplary. It was exciting to watch my theory being vindi­cated in practice. While I was traveling around the world danc­ing, lorillard was steadily dancing about in its box. It would do this for a short time and then, with an impeccable, almost predictable thrust, move into the box above, lorillard boxes began piling on top of each other like a beautifully constructed pyramid. I watched them fascinated. I had never seen a stock behave so perfectly as this. It was acting as though my theory had been built around it.

On February 17, 1958, lorillard bounced up to 44⅜. I was feeling very pleased with myself and the stock when, two days later, I received a cable in Tokyo which frightened me.

In one single day my stock had dropped to a low of 36¾ and closed at 37¾.

I was baffled. This move was completely unexpected. I did not know how to explain it. I rapidly cabled New York and raised my stop-loss to 36, less than 2 points below the day's closing price. I felt if it dropped there, I would be sold out and still make a nice profit on my first purchase.

As I was in Tokyo, I could not know the Wall Street rumors which had driven the stock down that day. All I knew was that it acted badly. Later I found out there had been a report saying that filter-tips were not so efficacious against lung cancer as they were claimed to be and this had panicked a lot of people out of the stock.

Fortunately, the setback was very short, and my stop-loss was not touched off. This convinced me of the stock's power and I decided to buy an additional 400 shares. I paid 38⅝.

Almost immediately we left this price behind. The quotes came in: 39¾-40¼-42.

I was very happy. I felt as if I had become a partner in an immense new development. Everything looked as if I had planned it.

It was at this time that I received from my broker three weeks' issues of a well-known advisory service. Week after week this service strongly urged its subscribers to sell lorillard short. The third recommendation read like this:

"Lorillard was obviously under distribution around 44 last week after we told you to start it on the short side."

This amazed me, but I had long ago become so disillusioned with advisory services that I did not pay attention to it.

Instead I started to recommend lorillard to any American tourist who mentioned stock market to me. I was genuinely try­ing to be helpful. My enthusiasm is best illustrated by what happened one day in the Erawan Hotel in Bangkok. One after­noon at lunch I was introduced to the president of one of the largest American shipping companies. During our conversation he mentioned that his holdings in the stock market amounted to $3,000,000. They were broken up in the following way:

$2,500,000 worth of standard oil (new jersey) $500,000 worth of lorillard.

"What do you think about it?" he asked. What did I think of it? He could not have asked a better man.

I immediately told him to sell all his holdings in jersey standard and switch his funds into lorillard. That was what I would have done.

A year later I met him at a party in New York, lorillard was then above 80.

"What's your latest stock market advice?" he asked me.

"Advice?" I said. I was astonished. "Wasn't that $3,000,000 worth of advice I gave you in Bangkok enough?"

"It would have been," he said. "If I had followed it." In the third week of March 1958, lorillard entered on an even more definite upward-thrust. It jumped 4 1/8 points in one week, its volume increased to an astounding 316,600 and it established itself decisively in the 50/54 box.

In the second week of April LORILLARD left its new box. It pushed through to a new high of 55¼ but immediately dropped back to its former 50/54 box. As I did not contemplate a further purchase this did not upset me unduly. However, I cautiously raised my stop-loss to 49.

I also wavered for a moment, on the verge of selling, but I decided against it. By now I had trained myself to be patient and, although I could have taken an easy $20 per share profit on my earliest purchase, I sat back determined not to take too quick a profit.

My cost figures for lorillard were:

200 shares at 28¾ $5,808.76
200 shares at 35 $7,065.00
200 shares at 36½ $7,366.50
400 shares at 38⅝  $15,587.24
Total 1,000 shares $3 5,827.50

I carried the last three purchases on 50% margin. This enabled me to keep the rest of my capital for a further investment, which turned out to be a stock called diners' club. I first became interested in this stock at the turn of the year, while I still battled with lorillard.

diners' club had just split 2-for-l, and in the last week of January 1958 its weekly volume swelled to 23,400, which I con­sidered unusually high for this stock.

As this increase in volume was accompanied by an advance in price, I decided to check the stock's fundamentals. They were reassuring. The company was a near-monopoly in an ex­panding field. The credit-card system, of which it was one of the pioneers, was firmly established. The company's earnings were in a definite upward trend. With these factors in mind, I bought 500 shares at 24½. My stop-loss was 21 ⅝

Now the question was which direction the stock would take. My first lorillard purchase had already shown me a profit, and I reasoned that if it came to the worst, I would lose it on diners’ club. But I did not. A few days after my purchase, the stock began to advance.

According to my theory, I immediately bought another 500 shares—at 26 1/8. On both buys, I took advantage of the new 50% marein.

The pattern evolved perfectly—first a   28/30 , then a    32/36   box. The last penetration was accompanied by a volume of 52,600 shares for the week. This was higher than any other week’s volume in the newly-split stock’s history.

As I saw my profits piling up, I did not for a moment forget to trail my stop-loss insurance behind the rise. First I raised it to 27, then to 31.

In the fourth week of March the stock penetrated a new   36½ / 40   box and seemed to establish itself there. I summed up my position in DINERS’ CLUB. I had brought:

500 shares at 24½ $12,353.15
500 shares at 26⅛ 13,167.65
Total 1,000 shares $25,520.80

I already had a profit of more than $10,000. Still, according to my theory, I had to hold on. The stock behaved as if it would go even higher. Every indication pointed to that.
But suddenly, unexpectedly, my cables began to read differ­ently. It was difficult to understand why, but I began to feel uncomfortable. The stock seemed to have lost its will to rise. It looked as though its last pyramid would hesitate on the brink of going into reverse. It almost seemed ready to tumble. So as not to get caught in any collapse, I decided to raise my stop-loss to the unusually narrow margin of 36⅜.

In the fourth week of April, the event against which I had insured myself occurred, diners' club broke through the lower limit of its box and I was sold out. I received $35,848.85. I had made an overall profit of $10,328.05.

For the first time—as I sat in my room in the Imperial Hotel in Tokyo with the cable in my hand, which said I had made $10,000 profit—I felt all my study and worry over the past few years had been worth it. I was beginning to come out on top.

Six weeks later I received news, which in some ways made me feel more elated than the $10,000, because it completely con­firmed the technical side of my approach. It was officially an­nounced that American Express had decided to launch a rival to Diners’ Club. This had been the reason for the hesitation of the stock near the 36 mark. Some people had known this before the announcement and were selling out. Without knowing about it, I was their partner.

Being in the Far East, I could not possibly know of any rival organization being set up. Yet the technical side of my system based on the price action had warned me to get out.

During all the time that I spent with loriixard and diners' club, I never neglected to follow the quotations of other stocks in Barron's. This began to show me that there was a great interest springing up in a stock called E. L. bruce, a small Memphis firm. The stock was quoted on the American Stock Exchange. On closer examination, I learned that the company made hardwood flooring. This most certainly did not fit my fundamental requirements, but the technical pattern was so compelling that I could not take my eyes off it.

What amazed me was the movement of e. l. bruce on Street. It usually traded below 5,000 shares a week. Then it sud­denly woke up and started to move. In the second week of April 1958, its volume rose to an astonishing 19,100 shares. There­after the weekly volume climbed to 41,500—54,200—76,500 shares, with the price jumping 5 to 8 points weekly without any sign of downward reaction.

bruce went from 18 in February to 50 at the beginning of May. Only then came its first reaction, which carried it back to 43J4. I could not be sure, of course, but this reaction seemed to me only a temporary halt, a refueling. I felt it would con­tinue to rise. I tried to find a fundamental reason, but I could not. Still, the volume was there, the price action was there, the rhythm of the advance was there.

I began to feel like a man sitting in a darkened theatre, wait­ing for the curtain to go up on a thriller. As I flew from Tokyo to Calcutta, I puzzled over the bruce quotations every hour of the way. It had a wider, freer range than most stocks, and I could not place a definite frame around it. Flying over the Indian Ocean, I made up my mind to make an exception. Funda­mentals or no fundamentals, if it went over 50, I would buy it, and I would buy a lot of it.

But I needed money. My diners' club sale had released some of my funds, but that was not enough. I could have used my savings, but after the jones & laughlin disaster I had decided never again to risk more money than I could afford to lose with­out ruining myself. Consequently I have never again added to my market funds from my show-business income.

The only possible thing to do was to take a close look at my old friend lorillard. Was it still behaving well?

It was not. Its penetrations were not decisive, its reactions were deeper. I decided to take my money out of lorillard and be ready to invest it in bruce. I sold my 1,000 shares the second week in May for an average price of 57⅜. The total price on the sale was $56,880.45. My profit on the deal was $21,052.95.

This, with the $10,000 I had made from diners' club, meant that in five months I had nearly doubled my capital. I felt pleased and proud and ready, like a giant-killer, to deal with a powerful and erratic stock like bruce.

I made special preparation for this fight. I had concluded after the lorillard deal that my system was working so well that I did not want to entrust it into the hands of one firm. I felt if anyone were to follow my operations, this might make it difficult for me. I called New York and opened accounts with two other brokerage firms.

In the third week of May 1958, I cabled New York to buy 500 bruce at 50¾ with my automatic on-stop buy order. I put in a stop-loss of 48.

In the following days the stock acted so beautifully that I decided to take full advantage of the existing 50% margin con­ditions. When I saw that my stop-loss was not touched off I pro­ceeded with further purchases, each of which was protected by stop-losses between 47 and 48. I figured that, should I be stopped out, I would only lose my diners' club profit.

These are the details of my purchases:

500 shares at 50¾ $25,510.95
500 shares at 51⅛  25,698.90
500 shares at 51¾ 26,012.20
500 shares at 52¾ 26,513.45
500 shares at 53⅝ 26,952.05
Total 2,500 shares $130,687.55

My timing was right, e. l. bruce really began to climb as if drawn upwards by a magnet. As I watched it, I became amazed at the way it soared. It was spectacular.

I just sat in Calcutta gazing at my daily quotes. Soon they told me the stock had surged over 60. After a slight hesitation, it suddenly broke out again. By June 13th, it had advanced to 77.

It was obvious even in faraway India that something fantastic was happening on the American Stock Exchange. I had to fight a hard battle with myself not to phone New York and find out what was going on. No, I said to myself as I felt like calling my brokers, that will only mean rumors and you may do something silly.

No man's resolution and patience were more severely tested than mine as I sat in the Grand Hotel at Calcutta, wondering what Wall Street was doing.

A few days later my nail-gnawing impatience was changed to terror by a call from New York. It was one of my brokers, and he nearly stopped my heartbeat. He said: "They have suspended trading in bruce on the American Stock Exchange." I nearly dropped the phone as I listened. I was terrified. Stopped trading in bruce stock! I had over $60,000, my entire capital, invested in it. Did this mean I had lost my money? It was with some difficulty that I was able to concentrate enough to listen. It was minutes before I recovered enough to hear what he had to say.

With my emotions running amok, it took me a long time to understand that far from being broke, I now could sell bruce for $100 a share in the over-the-counter market. I was com­pletely confused. $100 a share! What was this?

I was trembling while he told me the story over the telephone from New York to Calcutta.

Certain traders on Wall Street, basing their views on a purely fundamental approach, had decided that bruce's book value and earnings indicated that the stock's price should not be more than $30 a share. Therefore, they had started to sell the stock short between 45 and 50, confident they would be able to fulfill their bargains by buying it back at a price much nearer 30.

They made a grave mistake, because there was one factor they did not know about. A New York manufacturer named Edward Gilbert was trying to oust the Bruce family from con­trol of the company. He and his associates were trying to obtain a majority of the 314,600 shares outstanding which the Bruce family owned. It was this move that had rocketed the price. The volume was terrific, and more than 275,000 Bruce shares were traded during a period of ten weeks.

The short-sellers who had so misjudged the market jostled each other to push the stock to dizzy heights in their frantic efforts to buy it. They were caught with their pants down by the mysterious upward surge of the stock and they could not buy the shares at any price to fulfill their obligations.

Finally, as it was impossible to assure an orderly market be­cause of the frenzied dealings, the American Stock Exchange suspended trading. But this made no difference to the desperate short sellers. They still had to deliver the stock. Now they were willing to pay anything over-the-counter for bruce.

I listened in a daze to all this. My broker asked me whether, since the over-the-counter price per share was now 100, I would instruct him to sell at this price.

I thought back to my daily cables, and how they had begun to paint an amazing picture of bruce to me. I remembered the ordeal I had undergone as I steeled myself not to telephone to find out what was happening because this would come under the heading of "rumors" which I had sworn never to listen to again. I recalled how I held on while my daily quotes revealed to me bruce's sensational upward progress, and I did not know what to do.

Should I still hold on? I was faced with a very hard decision. I was offered a big, tempting profit. As I listened to my broker, I felt strongly urged to sell the stock. After all, selling at 100 meant I would make a fortune.

I thought hard while I listened. Then I made one of the most momentous decisions of my life. I said: "No, I will not sell at 100. I have no reason to sell an advancing stock. I will hold onto it."

I did. It was a big decision and a difficult one, but it proved exactly right. Several times within the next few weeks I received urgent telephone calls reporting higher and higher offers for my shares from brokers in various parts of the United States. I grad­ually sold out the stock on the over-the-counter market in blocks of 100 and 200 shares—for an average price of 171. This was my first really big killing in the market. I made $295,305.45 profit on this operation.

This was a tremendous event for me. I was so happy I did not know which way to turn. I told my story to everyone who cared to listen. I showed my telegrams to them. The only reaction was: "Who gave you the tip?" I tried to explain that no one had given me a tip, that I had done it all by myself and that I was so happy and excited exactly for that reason.

Nobody believed me. I am sure that every one of my friends in Calcutta still believes today that Mr. Gilbert himself had taken me into his confidence.


Are You Ready To Move Onto The Next Chapter? Click Here...

IMPORTANT: Would you like to download Darvas’ story in PDF & MP3 format?
Click Here To Download It Now





COPYRIGHT (C) 2008 WWW.NICOLASDARVAS.ORG | Darvas Trading | STOCKMARKET ARTICLES