Beware of Robinhood and Their Merry Band of Day Traders
Why do some individual investors insist on losing money day-trading stocks?
I do get the theory. Spikes in volatility provide huge swings in stock prices and seem to offer incredible returns if you’re on the right side of the price move. The problem is making sure you’re on the right side of the price move consistently. It is not easy to do, and day-trading is most often a losing proposition.
Larger institutional traders have an edge, but that edge comes from the investment they made in the technology necessary to be nimble. In other words, it costs money to make money. These institutional traders have powerful computing algorithms directing their activity, and the computing power to get in and out of stocks fast.
The latest enticement to day traders is the allure of zero commission rates. Costless trading theoretically gives an edge back to the day trader... except it actually does not. A zero-cost bad investment strategy is still a bad investment strategy, it just costs less.
Robinhood was launched in 2013 as a no-fee trading platform that became quite popular with younger investors, and their platform has grown its user base from 1 million users in 2016 to 10 million today. That’s a lot of individuals trading stocks on just this one platform.
That said, having the tools to trade no more qualifies you as an investor than having a hammer makes you a carpenter. To be successful, you need knowledge, skills, and a proven strategy. Day traders often lack all three.
Then there’s the illusion created by social media. We’d call this the “strength in numbers” illusion. Young investors are well connected online, and this network of ideas can often lead them like lemmings off a cliff.
In days gone by, they were called pump and dump schemes.
You may recall Yun Soo Oh Park - AKA Tokyo Joe.
Back in the dot.com era, Tokyo Joe went from obscurity pumping gas to pumping stocks in internet chat rooms. In an unfortunate interview with Money Magazine, Park described his approach as follows: “Everybody knows that I’m buying before you buy, and I’m selling when you’re buying. Otherwise, what am I? A charity?”
The SEC stepped in and sued Tokyo Joe for fraud.
David Portnoy, founder of Barstool sports, is making headlines with his day trading exploits during the Covid-19 pandemic. With professional sports on hiatus, Portnoy began his Davey Day Trader livestream on Twitter on March 23 according to CNBC.
Portnoy funded an E-Trade account with $3 million admitting that he knew very little about stocks or trading. He even warned his followers not to follow his advice. Well then, why do the stream? But I digress.
Nonetheless, it was good advice.
According to Business Insider, Portnoy is down some $647,000 in his trading account. Anyone following his trades would have had similar losses.
Noted Princeton economist, Burton Malkiel stated in a blog that we are in the midst of a “day trading pandemic.”
Malkiel wrote, “The coronavirus has wrought devastating harm to the health of our nation and the vibrancy of our economy. With respect to financial markets, it has also given rise to a full-blown mania. Individuals cooped up at home, working remotely on flexible schedules, with no social activities and no live sports, have increasingly turned to day trading in the stock market.”
He further cites a study in Brazil that found only 1% of day traders made more than the minimum wage—day trading simply does not work.
Example: over on Robinhood, fueled by social media tweets, day traders recently targeted bankrupt car rental company, Hertz (NYSE:HTZ). In early June, the power of the mob took this penny stock from a price of below $1 per share (and falling) to over $5 by the middle of the month.
So strong was the demand, those in charge of managing Hertz’s bankruptcy announced they would be selling more stock in order to raise capital for creditors.
The offering was cancelled after the SEC questioned the sale of new stock from a bankrupt company, of course. Robinhood traders apparently got the message and Hertz shares fell back to just over $1 per share as of June 23.
Bottom line, before you get the urge to day-trade a stock or follow someone else doing the same, please give us a call. We can help talk you off the ledge.