A Look at the Bleak Prospects for Day Traders

Markets Motley Fool

In this episode of Industry Focus: Consumer Goods and as part of our "Never Will I Ever" theme week,  the team explores the pitfalls of day trading with a detailed example of how the bid-ask spread, or the "vig" in gambling terms, can quickly gobble up a trader's capital over a single year.

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Our test case is footwear manufacturer Deckers Outdoor Corporation. If you’re thinking of becoming a day trader, you should watch this video segment before taking the plunge!

A full transcript follows the video.

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This video was recorded on July 11, 2017.

Asit Sharma: Vince, have you ever put on a pair of Uggs in your life?

Vincent Shen: Yes, I have tried a pair on. I've never owned them myself, but I have tried them on. They're pretty comfortable.

Sharma: Wonderful. We are, of course, referring to Deckers Outdoor Corporation. This is the maker of Ugg boots, which was a very popular item a few winters ago. The stock has been up and down. Vince, if I'm not mistaken, we currently have a buy recommendation on that stock at The Motley Fool, correct?

Shen: I believe so.

Sharma: So the Motley Fool is saying, "This is a long-term investment, in a Foolish way. Don't trade the stock, but buy it and hold it." A few specific technical things about this stock, how it trades on the market. If you go past recent history, its last few trading weeks, DECK, Deckers Outdoor Corporation, I'm just going to call it DECK for short, has a long-term beta of 2.0. That means it is twice as volatile as the market. And I checked the spreads on the stock this morning. The stock trades between $66 to $67, so let's just, for conversation's sake, say the stock trades around $67 right now. The bid-ask spread was fluctuating this morning anywhere from $0.03 to $0.12. So Vince, I'm going to ask you a question. Do you think that such a narrow spread -- let's take the middle of that, about $0.07 -- would have any impact on someone who traded the stock frequently?

Shen: Yeah, absolutely.

Sharma: That's why they pay you the big bucks, you have a lot of brain power. It took me losing money to figure this out in the markets. Let's take this example of $0.07. Investors out there who've dabbled in trading, assume that you're trading this stock, and you have a stake of $6,700, that's 100 shares. And let's, to make the example simple, assume that your broker lets you trade on margin, which means you can trade the stock more than once a day. Let's say that you have two round trips a day. So, at a bid-ask spread of $0.07, that's the bid that you're giving up to the house, if you trade that stock two times a day, that's $14. That $14 multiplied by 250 trading days, assuming you're going to make good enough money to take two weeks off for vacation, that equals $3,500. So, we're talking about an initial stake of $6,700. More than half of that is just going to the vig, to the house, if you're trading the stock only twice a day.

Now, let's talk about commissions. Those who trade often have probably researched, there are some brokerage houses, like Interactive Brokers, which only charge $1 per round trip. Four round trips in a day is $4 time 250, is another $1,000 on top of that $3,500. If you're going with the more traditional discount broker, even one that's only charging $5 a trade, that's $5,000 in commission, plus the $3,500 that you paid in vig. In one year, if your commission is $5, you will have $8,500 of trading costs on an initial trading stake of $6,700.

Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool recommends Deckers Outdoor. The Motley Fool has a disclosure policy.