To make proper investment calls, investors must know different theories and schools of thought they can follow. As a follow up on the investment theory series, this article covers Odd Lot Theory.
What is the Odd Lot Theory?
The odd lot theory is a systematic examination proposition based on the hypothesis that the small individual investor is usually wrong. It also assumes that individual investors are more likely to produce odd-lot sales. Consequently, if odd-lot sales are up and small investors are selling a stock, it is probably a good time to buy, and when odd-lot purchases are up, it may indicate a good time to sell.
Odd Lot Theory in Detail
The odd lot theory centres on following engagements of individual investors dealing in odd lots. To increase pricing effectiveness in their orders, professional investors and traders tend to trade in round lot sizes (multiples of 100 shares), as this theory undertakes. Although this thinking was common practice from about 1950 until the end of the century, it has since become less popular.
- Testing of this hypothesis seems to indicate that this observation is not obstinately practical.
- Odd-lot trading is a group of shares less than a round lot of 100 shares.
- These odd-lot trades are thought to be disseminated by individual traders who are considered to be the less knowledgeable participants in the market.
Odd Lot Trades
Trade orders made by investors that include less than 100 shares in the transaction or are not in multiples of 100 are called Odd Lot Trades. These trade orders commonly incorporate individual investors which the theory believes are less sophisticated and prominent in the market overall.
Round lots are the opposite of odd lots. They are divisible by 100 and begins at 100 shares. These trade orders are seen to be more attractive as an indicator as professional traders or institutional investors typically make them.
Although technical analysts can monitor the volume of odd-lot trades through technical analysts monitoring software programs, records show that this kind of trading doesn’t connote market turns that much. While the odd-lot theory implies that these investors may be more important to follow for trade signals, this concept has become less critical to analysts over time.
There are several reasons for this. The first reason is that individual investors began investing more heavily in mutual funds, which pool money into the hands of established investors. The second reason, fund managers and individuals alike began using exchange-traded funds (ETFs), with the large volume being reasonable for the most popular ETF assistances. A third reason is the amplified automation and automation of market-making firms and the increased technology of high-frequency traders. Order processing has become far well-organized because of these factors. The greater effectiveness of the markets has meant that odd lots are not administered any less adequately than round-lot orders.
Testing the Odd Lot Theory
The general effectiveness of the odd-lot theory has been disproven after its analysis in the 1990s. Traders no longer fear making trades in odd lots because individual investors are not generally prone to making wrong investing decisions.