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Odd Lot Theory

Candlefocus Editor
The Odd Lot Theory (also known as the Threshold Quantitative Model) is an investment strategy that suggests that higher returns are more likely to be earned by trading against the orders of smaller, odd-lot traders. Odd-lot traders are usually thought of as small, retail investors of stock. These investors typically trade in odd lots, or amounts of less than 100 shares, often with the help of a broker. It is assumed that these traders are less informed and less sophisticated in their investment decisions than other types of investors.

The idea behind this theory is that these less informed traders buy or sell stock at prices that are not accurately reflective of the true value of the stock. As a result, their orders often result in the stock being slightly overvalued or undervalued. Rather than joining the uninformed traders in their trading activities, the theory advocates for trading against these investors in order to capture the generated profit.

The Odd Lot Theory has been tested in multiple academic papers over the years, but the results have been mixed. In some cases, the theory has been found to hold true, while in other cases it has not been found to hold any predictive power. Generally, this suggests that the Odd Lot Theory’s validity may be limited or non-existent in the current investment industry.

Despite the inconclusive evidence, investors use the Odd Lot Theory as a guideline for their investment decisions. However, to implement the theory successfully, investors need to look beyond just odd-lot times, but also consider other factors like market cycles, sector performance and company developments. The Odd Lot Theory should be viewed more as a suggestion based on the evidence that has been gathered, rather than a set-in-stone rule book for stock trading.

Overall, the Odd Lot Theory provides a valuable insight into the behavior of less informed traders and highlights the potential discrepancy between the aggregate wisdom of the market and the individual decisions of small investors. Whilst this theory has been tested and found inconclusive, it still serves as a mean for investors to identify potential edge over the rest of the market.

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