The Darvas Effect

Market optimists who have been awaiting the "traditional" summer rise took it on the chin last week. For the second week in a row, each day the market closed lower than the day before, at Friday's closing was down 20.37 on the Dow-Jones industrial average to 609.87--the biggest weekly drop since March, and only eleven points above the year's low. The New York Times combined average of 501 stocks hit its worst point since November 1958. But there was no rush to sell. Volume averaged a thin 2,500,000 shares daily as the market drifted down. "People are uncertain," as Walston & Co.'s Edmund W. Tabbell put it. "They're not scared enough to sell, but not certain enough to buy." Perhaps some of the uncertainty was caused by the rumblings from Khrushchev, the Congo and U.S. politicking. But the biggest worry was over the question of when business would show more of an upsurge.

Despite a lot of talk about disappointing second-quarter earnings, many investors seemed to buy and sell for other reasons. The stocks of Budd, Goodrich. Liggett & Myers and American Steel Foundries, for example, all rose despite lower earnings reports. A.M.F., Burroughs, Crown Zellerbach, General Foods and Gillette all fell despite the fact they had higher earnings.

Stop Loss. A phenomenon of the market in recent weeks has been a flurry of sudden, sharp drops in such old favorites as Brunswick, Universal Match and Thiokol. Many brokers blamed such flurries on the thinness of the markets: a comparatively small number of shares, bought or sold, cause a big change in price. To make markets broader, the New York Stock Exchange argues that margins, which now require a buyer to put up 90% of the price, should be reduced, since there is far less credit buying in the market than in any other segment of the economy. But the Federal Reserve Board has shown no signs of giving in.

Other brokers laid the blame for the sudden jumps and dips at the dancing feet of Nicolas Darvas, of the ballroom team of Darvas and Julia (TIME, May 15, 1959). His book, How I Made $2,000,000 in the Stock Market, published five weeks ago, has already sold more than 100,000 copies. A key part of Darvas' system is the use of the "stop-loss order"; e.g., an investor with a stock selling at 40 instructs his broker to sell if the price dips below 38 to limit his loss. The catch is that if the only bid at the moment happens to be several points lower, the broker is required to sell. Thus, the seller who hoped to limit his loss to fractions of a point often takes a far bigger loss. When investors who have been waiting to buy at, say, 35^, see the drop and rush to buy, the stock shoots back up again.

The Thirteen. Stop-loss orders have increased 25% in the past five weeks, Specialist John Coleman estimates, and have nearly doubled in some of the glamour stocks. The result: whenever the price dips, the stop-loss orders set off in a chain, and the stock plummets. Standard Kollsman stock was caught this way recently: the exchange canceled all Kollsman stop-loss orders on the books, has yet to restore them.

What most readers of Darvas' book fail to realize is that the stop-loss order method must be used, as Darvas does, with the skill of a professional trader; it is not for amateurs. To stop the sudden swings, the floor governors of the exchange are closely watching 13 stocks with an unusual volume of stop-loss orders, have held several meetings to discuss the problems presented by the "Darvas Effect."

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