What is Odd-Lot Theory?
The odd-lot theory states that an increase in odd lot activity is a buy signal in a market.
How Does Odd-Lot Theory Work?
An odd lot is a group of shares that is not a multiple of 100 (100 shares is called a round lot). Typically, individual investors are the most likely to hold odd amounts of shares (for example, a single share of Disney given as a birthday gift or 20 shares of Exxon purchased with savings). Thus, trades involving odd lots are typically associated with individual investors.
In turn, when the volume of odd lot trades increases, analysts take this to mean that individual investors are more active in the market. What the odd-lot theory hinges on is that these individual investors are less experienced and are almost always wrong. Under the odd-lot theory, when odd-lot sales increase, institutional investors consider it a time to sell.
Why Does Odd-Lot Theory Matter?
The odd-lot theory is not just a theory about buy and sell signals. It is a theory about the sophistication and behavior of individual investors. Interestingly, the data supporting the odd-lot theory is controversial and in some cases unsupportive.