For those who are not familiar, at the exchange, you can trade stocks in a standardized unit, such as multiples of 10, 100, or 1000 shares. This makes calculations easier while executing trades and exchanging securities between two parties. But what about small investors who want to avoid investing in a stock in huge chunks? Well, they, too, can invest in the stock market in odd lots. To know what is an odd lot and what is the Odd Lot Theory, continue reading the article.
What is an odd lot?
To understand the Odd Lot Theory better, you first need to understand what is an odd lot. If the number of securities you are trading is less than the standardized unit of trading, say 100 or 1000, then the lot being traded in known as an Odd Lot. Generally, a stock order of fewer than 100 shares is considered odd.
What is an Odd Lot Theory?
This theory is based on the assumption that small individual investors are more likely to enter odd lot trades than institutional investors. Therefore, according to this theory, if odd lot sales increase and small investors are selling a stock, it is a favorable time to buy. Conversely, if odd lot purchases are up and small investors are purchasing a stock, it is considered a good time to sell.
Assumptions of the Odd Lot Theory
Just like any other theory, the Odd Lot Theory is also based on a few assumptions. The following are a few assumptions:
- It analyzes odd lot trades falling below 100 shares.
- It believes that small investors are likely to trade more in odd lots than small individual investors.
- It assumes that small investors are generally wrong about trade timings; thus, investors who follow this theory trade in contradiction to what the odd lot trades signal.
Limitations of Odd Lot Theory
Over time the theory was tested by many analysts who disapprove of the effectiveness of its theory. This is mainly because small investors are not prone to making bad investment decisions, as this theory assumes. Also, individual investors have started investing in mutual funds, reducing the number of odd lot trades.
Conclusion
The exchange has a standardized number of shares you can buy/sell in a single trade, but if the stock order is of less than standardized units, it is known as an Odd Lot. According to the Odd Lot Theory, traders trade in contradiction to what the odd lot trade signifies. This means if the odd lot purchases by small investors are up, it is a good time to sell, and vice versa. However, you must know that many analysts have contradicted the theory over time and thus have lost its relevance.
Disclaimer
- This blog is exclusively for educational purposes
- Investments in the securities market are subject to market risks; read all the related documents carefully before investing
