Investors "short" a stock in anticipation of the stock's price falling. Instead of the
traditional transaction of buying at a lower price and profiting by selling at a higher
price, the short sale transaction is just the opposite. To profit from a short sale, the
stock must be sold at a higher price and bought (covered) at a lower price An "odd lot"
short is a short sale transaction involving less than 100 shares.
If we could find an investor who was always wrong and do the exact opposite of him, we
would always be right! Odd lot indicators strive to do just that. If we assume that small
investors ("odd lotters") are inexperienced (and thus usually wrong), then trading
contrarily to the odd lot traders should be profit-able.
The higher the OLSR indicator, the higher the percentage of odd lot shorts and the more
likely the market will rise (proving the odd lotters wrong). Similarly, the lower the
OLSR, the more likely a market decline.
Generally this rule (invest contrarily to the odd lotters) has held true. Odd lotters
tend to be reactive rather than proactive. High Odd Lot Short Ratios tend to come after
major market declines (when investors should be buying, not selling) and low readings
usually come after long market advances.
In 1986, the number of odd lot shorts reached levels that were unheard of. The
explanation I have heard for this is that specialists are placing multiple odd lot short
orders to avoid the up-tick rule which states that a short order must be processed on an up
tick. They do this on days with major declines in prices.
If this explanation is true, it drastically complicates the interpretation of all odd
lot indicators. It would mean that the odd lot indicators show what the "littlest" guy is
doing, except when it reaches extreme readings in which case it would show what the
"biggest" guy (the members) is doing.
