What is an odd lot?
An odd lot may sound like an odd concept, but it is easy to understand. If you have less than 100 shares of stock or any amount of stock between 1 to 99 shares, you are said to have an “odd lot.”
Comparatively, if you have stocks in multiples of 100, you have a “round lot.” Traditionally, trading commissions on odd lots are usually higher than standard round lots because brokers charge a fixed commission for this kind of transaction. But with the surge of online trading platforms like Stockpile, odd lots are now accessible to small investors for a fraction of the commission.
If you’re not willing to pay the expense of trading with round lots, then odd lots can be a viable option to consider. Many small investors prefer this method because it gives them the opportunity to buy smaller amounts of a particular stock, helping mitigate risk. Investors can also choose to purchase shares based on a set value instead of a specific number of stocks. For example, buying $200 worth of stocks from a company at $5 per share would result in having 40 shares.
The odd lot theory
Why is an odd lot important? Analysts assumed for a long time that individual investors who tend to buy odd lots are less experienced and therefore, the stocks they are purchasing are devalued by analysts. When there is an increase in odd lot buying, analysts take it to mean that small investors are active and it’s a good time for professional investors to sell.
They believed that while successful investors use facts and reason to guide their buying/selling decision, smaller investors do the opposite. For instance, when smaller investors buy shares of companies, they tend to choose ones that they have a personal connection to and use their feelings instead of cold-hearted logic as a guide.
Typically, when the stock market declines, professional investors view it as a time to buy because share prices are usually lower. Small investors, on the other hand, are likely to panic and sell their stocks. Due to their more limited resources, they can’t afford to wait until the market plummets. They have to recover whatever they can, while they can.
The theory is, if you follow the movement of odd lots and do the exact opposite, you will have a better-than-average chance of making a killing.
Disproving the odd lot theory
This kind of technical analysis was famous for a long time until actual research proved that timing your trading decision based on odd lot movement is not as effective as it was believed to be. Small investors are not as clueless and inexperienced as was once thought. Analysts found that while sales of small stocks rise when the market is falling, buying of odd lots did not. It proved that the data on the odd lot was not a reliable way to measure its activity.
Two things became clear: first, the odd lot theory is not a valid interpreter of buying and selling signals. Second, it’s also not a good indicator of a small investor’s trading sophistication. Additionally, the odd lot data that we have today no longer originates from small, unsophisticated investors. A lot of it comes from dividend reinvestment plans (DRIPs). Depending on a company’s payout formula, stockholders may get uneven shares of stock. Computers can also break down huge sales and purchase into smaller transactions resulting in smaller uneven stocks. This evolution of the stock market makes it difficult to look at the raw data and make conclusions based on odd lot behavior.
Although the theory is no longer popular, there are still investors that hold to its merits to predict market directions.