My Introduction to Retail Arbitrage

retail arbitrage

retail arbitrageWriting at Don’t Talk About Your Stocks and posting a bunch of trading quotes on twitter has given me a vehicle to communicate with A LOT of traders over the past few years. Talking to traders from all different levels of success has given me some insight into where most aspiring traders seem to get hung up.

In my observation, the biggest hurdle that new traders have to overcome is finding or developing an approach that has an edge and matches their personality. However, once this is accomplished, the next barrier many traders run into is finding enough capital to actually trade their strategy. (Sticking to their strategy is also a big struggle, but without the capital many traders will never get to that point.)

In Search of Income

I have worked very hard over the years and saved a few bucks so that I could experiment with trading. I have a pretty good job that pays all of my bills and allows me to live quite comfortably. However, if I could find a way to contribute an additional few thousand dollars to the DTAYS Quantitative Growth Fund every month, its growth potential would be more more impressive.

The QG Fund backtest showed an average return of 18% over the past ten years. If that were to continue into the future, the fund could grow $10,000 into $273,930.35 over the next 20 years. That’s great, but contributing an extra $1,000 each month turns that end number into more than $2 million. Now we’re talking about some serious cash.

I’ve tried a lot of different strategies to build additional income streams that I could feed into my trading account. First, I started DTAYS and then quickly gave up on the idea of ever making real money through Google AdSense.

Then, I started freelance writing, and that went really well. I was able to build my side income up to more than $2,000 per month. That would bump the 20 year value of the fund to almost $4 million! The problem with freelance writing was that it was just as demanding as my primary job, which led to me working from 6 am to midnight every single day.

Amazon FBA

About a month ago, I heard an interview on Pat Flynn’s Smart Passive Income Podcast with a lady who was making a six figure income through a process called Retail Arbitrage. She was basically buying clearance items at local stores and then selling them for full price on Amazon.

The kicker with this idea was that she was using the FBA program, which stands for Fulfillment By Amazon. What that means is that you pack up all the junk you have listed for sale and ship it off to Amazon’s warehouses. Then, when someone buys one of your items, Amazon takes care of picking and packing the item, shipping it to the customer, and collecting payment. For their part, they keep about 30% of the sale price.

That means that if I can find things that sell on Amazon for three times what I buy them for, I can double my money after Amazon takes their cut. That’s pretty cool.

Why Does This Work?

Why would people pay full price for something they can get cheaper at Walmart or Target? That was my biggest mental hurdle.

The answer is actually quite simple. If they are Amazon Prime subscribers, they get free 2-day shipping on anything they order that is fulfilled by Amazon. That means they can get it delivered right to their doorstep, and many people are willing to pay up for that convenience.

Some are willing to pay more for products delivered to their doorstep because they live miles from commercial shopping areas. Other people are willing to pay up simply because they are too busy to be bothered with running to the store. (Maybe because they are tied up starting at stock screens day trading!)

I’ve only been experimenting with this idea for a few weeks, and I’m not convinced that it is a viable business model just yet, but it is very interesting to see the way many of the trading principles we have talked about apply here.

Real World Trading Principles

When I’m out looking for things to purchase, I am basically looking for value in items that other people in my community have overlooked. I’m also looking to either buy low and sell high, or buy high and sell higher.

Riding the Trend

In classic trend following fashion, when I find something that works well I am attempting to get as much money into that product as possible in order to ride the current trend. One great example of this is the Disney Frozen Beauty Sets I sold. I picked up two of these at my local Walgreens for about $7 each and almost immediately sold them for $22. After seeing how well they sold, I drove to six different Walgreens in search of more and found four more sets at an average cost of about $5 each.

Risk Management

The flip side of that is that risk management also comes into play here. When I see what looks like a good item, I have generally been starting with just two, even if I have access to 10 or 20. I want to let an item prove itself to me before I commit too much capital and expose myself to not selling it.

Commissions & Slippage

Another way that Amazon FBA selling compares to trading is that you have to accurately account for commissions and slippage. There are quite a few items that I can buy at my local Dollar Tree for $1.06 and sell for $5 or $6 on Amazon, but after Amazon takes their commissions on these low-priced products, there isn’t much profit left to be had. There will also be shipping damage and product returns that will create slippage.

Cutting Losses

I will also have to explore the appropriate time to cut losses on products. Just like buy and hold investors, I can sit on products indefinitely, waiting for someone willing to pay my price. However, the cost of tying up that capital might mean that it makes more sense to sell a dud product at a loss and move that money into something more profitable. This means that I have to be able to change my mind about a product (or position) in an instant.

Progress Update

So far, I have invested about $400 into inventory and that has produced about $400 in sales. Using very rough estimates, that means Amazon’s commission is about 132, so I have $268 left. That means that I haven’t quite broken even, but I still have something like $1300 in retail value inventory. The question is if and when it will sell.

I’m going to continue investing little by little in inventory. The potential of 100% ROI is very exciting, but the items have to actually sell before that is possible. Either way, I think this will be a fund case study to explore and could possibly be a great way for aspiring traders to turn  few hundred dollars into a few thousand dollars into enough to bankroll and continue contributing to their trading.