What is the Odd Lot Theory
The odd lot theory is a technical analysis theory based on the assumption that the small individual investor trading odd lots is usually wrong. Therefore, if odd lot sales are up and small investors are selling a stock, it is probably a good time to buy. Vice versa, when odd lot buys are up the odd lot theory would indicate a good time to sell.
BREAKING DOWN Odd Lot Theory
The odd lot theory focuses on following activities of individual investors trading in odd lots. The theory was broadly considered in the 1950s and 1960s. It has since become less popular, after individual investors began investing more heavily in mutual funds and data studies in the 1990s showed little effectiveness in the implementation of the theory.
Odd Lot Trades
Technical analysts have the ability to follow the volume of odd lot trades through technical analysis charting software programs. Odd lot trades are trade orders made by investors that include less than 100 shares in the transaction or are not a multiple of 100. These trade orders generally encompass individual investors which the theory believes are less educated and influential in the market overall.
Round lots are the opposite of odd lots. They begin at 100 shares and are divisible by 100. These trade orders are seen to be more compelling as an indicator as they are typically made by professional traders or institutional investors. The odd lot theory infers that these investors can be more important to follow for trade signals since they are typically more educated with greater amounts of available insight for investment decisions.
Odd Lot Theory Assumptions
The odd lot theory uses the analysis of odd lot trades as its basis. It primarily focuses on trade orders of less than 100 shares. Its premise is built on the notion that odd lot trades can be counterintuitive to market trends. Therefore, believers in the odd lot theory seek to trade against the direction of odd lot trades. Thus, when odd lotters are buying shares the theory would indicate a signal to sell shares and vice versa.
Analysis of the odd lot theory, culminating in the 1990s, generally disproved its effectiveness. Discovering that individual investors are not generally prone to making bad investing decisions. Overall, the theory is no longer valid as many researchers and academics including Burton Malkiel have stated that the individual investor, also known as the odd lotter, is generally not as uninformed or as incorrect as the theory has stated.
In the current day environment many individual investors have moved to investing more heavily in mutual funds which alleviates the volumes of odd lot trades. Previous followers of the theory have become more indifferent to odd lot trades with most technical analysts placing more emphasis on overall volume indicators such as the Positive and Negative Volume Indexes that can be used to help spotlight institutional trading sentiment.