Odd Lot Theory - Explained
What is the Odd Lot Theory?
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Table of ContentsWhat is the Odd Lot Theory?How Does the Odd Lot Theory Work?Assumptions of Odd Lot theory
What is the Odd Lot Theory?
The odd lot theory refers to a technical theory that assumes that the small-scale investors dealing in the buying and selling of odd lots are wrong most of the times. Hence, when small-scale investors put a stock on sale, and the sales of odd lots have an upper hand, then as per the odd lot theory, it is considered to be a favorable time to buy. In case, odd lot buys have an upper hand, then it is a feasible time to sell.
How Does the Odd Lot Theory Work?
The odd lot theory emphasizes on the activities followed by small individual investors who have a major interest in trading odd lots. This theory got recognition in the 1950s and 1960s. However, with the emergence of mutual funds, the concept of odd lot trades lost its significance. As per the statistics in the 1990s, the theory was said to be less effective when implemented. Technical analysts use technical analysis charting software program for following the quantum of odd lot trades. Investors create these trade orders in a quantum of less than 100. Individual investors who don't have adequate knowledge and have less influence in the stock market usually use the trade orders. The term round lots is a mere reverse of odd lots. They start from 100 shares and are available in multiples of 100. As they are created by expert traders or institutional investors, they prove to be more influential than odd trades. The odd lot theory assumes that the opinions and views of these influential investors are more significant when it comes to following trade signals. This is so because they have more information and insights for making profitable investments.
Assumptions of Odd Lot theory
The odd lot theory analyzes or observes the odd lot trades, and further uses it as a premises. Its focus is on trade orders falling below 100 shares. It revolves around a basic assumption that it can be contradictory to the market trends. Hence, people who follow odd lot theory tend to trade against what odd lot trades signal. Therefore, when odd lot traders will be selling shares, it would hint buying shares, and in case, they are buying shares, it would give a sign to sell shares. The analysts of the odd lot theory negated its efficaciousness, and observed that odd lotters are not vulnerable to taking poor decisions when it comes to making investment. Researchers namely Burton Malkiel have stated this theory as useless, and added that the individual investors are not that uneducated or wrong as the theory suggests. Nowadays, individual investors have started huge investments in mutual funds that reduces the quantum of odd lot trades. Even the investors who were following or supporting this theory before have started acting indifferent towards the theory. Majority of technical analysts focus on the comprehensive volume measures including positive and negative volume indices that can be considered for identifying the emotions or sentiments behind institutional trading.