Odd-Lot Theory

The Odd-Lot Theory

This theory holds that except for the man who is always right, no person can contribute more to successful investment strategy than a man who is know to be invariable wrong. The “odd-lotter,” according to popular superstition, is precisely that kind of person. Thus success is assured by buying when the odd-lotter sells and selling when the odd-lotter buys.

Odd-lotters are the people who trade stocks in less than 100-share lots (called round lots). Most amateurs in the stock market cannot afford the $5,000 investment to buy a round lot (100 shares) of stock selling at $50 a share. They are more likely to buy, say, ten shares for a more modest investment of $500.

By examining the ratio of odd-lot purchases (the number of shares these amateurs bought during a particular day) to odd-lot sales (the number of shares they sold) and by looking at what particular stocks odd-lotters buy and sell, one can supposedly make money. These uninformed amateurs, presumably acting solely out of emotion and not with professional insight, are lambs in the street being led to slaughter. They are, according to legend, invariably wrong.

It turns out that the odd-lotters might be slightly worse than the stock averages. However, the available evidence (which admittedly does not match what has been accumulated in testing many of the other technical strategies) indicates that knowledge of his actions is not useful for the formulation of investment strategies.

Odd-Lot Theory. Photo by Elena

One of the available studies examines the theory that an investor can make use of data on odd-lot sales and odd-lot purchases in selecting stocks. Supposedly, a switch from net odd-lot buying (where odd-lot shares purchased exceed odd-lot shares sold) to net odd-lot selling (odd-lot sales greater than odd-lot purchases) should be taken as a “buy” signal, since the boobs who sell odd-lots obviously don’t know what they’re doing. The data did not support this contention. Indeed, the rule failed to indicate the major turning points for individual stocks or for the market as a whole. Moreover, the odd-lot index was a very volatile one, switching back and forth from net sales to net purchases quite frequently. This suggests that an investor who followed the strategy would incur very heavy brokerage charges, which would eat substantially into his capital.

With the exception of a few technicians who sell their services to the public, few professional investment people believe in the odd-lot theory anymore. Indeed, some professional applicable to today’s institutionally dominated market. Instead of looking at the behavior of the little guy in the market, it is suggested that the yo-yos who run the big mutual funds are the odd-lotters of today, and that investors should look at what they are doing and then do the opposite.

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.