This article provides an overview on the Odd-Lot Theory:- 1. Odd-Lot Theory 2. Short Sales 3. Confidence Index 4. Breadth of the Market 5. Relative Strength 6. Moving Average Analysis.
- Odd-Lot Theory
- Short Sales
- Confidence Index
- Breadth of the Market
- Relative Strength
- Moving Average Analysis
1. Odd-Lot Theory:
The Odd Lot Theory is a prediction of tops in the bull market price direction and the price reversals of each security. Odd lot is a method of trading shares in groups which are less than 100 shares. These become round-lots if they are traded in groups of 100 shares, 200 shares, 300 shares or more.
The odd lot theory suggests that it is important to find out information about groups of less than 100 because such investments are usually not made by professional investors. This would, therefore, reflect the views of the common man daily.
The method of finding out the daily record of odd lots is by gathering information on the number of shares which are purchased each day, those which are sold in the market and also those shares which are sold short.
The theory suggests that by charting out the ratio of odd purchases to odd sales it is possible to find out the direction of prices because it indicates the buying activity of the common man. If the odd purchases are less than the odd sales then it indicates that there is a positive purchase, on the other hand, there can be a negative purchase also. The odd purchases minus the sales are shown in the chart against a market index.
The net purchases by the odd lot according to the technical chartists show the movement of prices in the market. The analysis of the technical school is that, a fall in the market price is reflected if net purchases made by the common man are positive. If the net purchases are negative, then it reflects that the bear markets are at a close.
The theory of odd lot had been tried by the Dow Jones Industrial Average sometime during the years 1969-70 when there was a presence of a bear market. The chart showed just the opposite of analysts’ analysis.
It showed that the common man or the person interested in odd lots was purchasing net when the charts showed a low print. The theory has been opposed by the odd lotters because they buy low and sell high and make profits and this is contrary to the odd lot theory.
2. Short Sales:
Short sales is a method of covering up speculators’ short position in the market by buying securities at a lower price than the price at which the seller would sell them. Short sales are a means of covering up by the individual after finding out relevant information about the security in which the position is likely to be covered up.
The buyer and the seller both analyse the situation of the short positions to indicate the demand for the securities and thus try to cover their short positions which are outstanding. But when the demand increases then the outstanding short positions also increase and these are indications of future rise in price. These indications have also been tested on Dow Jones Industrial Averages.
These indications cannot be exactly correct and are only a general indicator. The technical analysts thus believe that short sales is a sophisticated technique and it is difficult for an average investor to understand its technique.
According to them, those who follow the short sales theory are not clear because when they expect a price decline it does not decline immediately and follows slowly. This technique can only broadly give certain indications.
3. Confidence Index:
The technical analysts analyse the market through a calculation of the confidence index. This index shows the ratio of yields between the types of bonds.
These bonds are the high grade bonds and the low grade bonds and the confidence index shows the willingness of the investor to invest in the market. This technique shows that the purchase and sale of investment from high grade to low grade bonds depends on the kind of confidence that the investor gains about the stock market price movements.
When the investor is confident that the economy is stable and the stock market is reflecting boom, gain and peak period, then they would like to take a risk in the market and try to gain high yields in the purchase of bonds.
The investors would make a gain by shifting their investments in such a manner that they are high yielding. This they are able to do by shifting their investments which they are already holding in high grade bonds to low grade bonds. High grade bonds are higher in equity but do not yield high returns.
Low grade bonds while risky will offer a higher yield. When the investor makes this change then the price of the low grade bond rises. When the prices rise the yield also falls and because the price of the low grade bond has increased this gives a boost to the investor and he becomes more confident of the low grade bond.
Usually, large institutional investors make portfolio choice in the bond market but it is the influence of the small investor and the change in his prices which is marketed by the technical chartists to find out the confidence index.
The confidence index is limited to points to upper limit being limited to one. When the confidence index is rising it indicates optimism and the technical analysts predicts that the money market is showing a chance for making speculative profit. At this time, most of the investors do not mind taking heavy risks and buying even low grade bonds.
The assumption is that the yields which are received on a high quality bond will be lower than the yield on low quality bond at all times. The technical analysts analyses the indicator of the confidence index to measure in a time period from two months to a maximum of eleven months.
But the confidence index also indicates a fall in the stock prices and shows that the low grade yields rise faster and fall slower than the high grade yields. A depression in the movement causes the investors to become risk averse and short time speculators do not take advantage of shift in prices from high grade to low grade bonds.
This is so because they expect a downward trend in the economy to follow. Research has shown that confidence index is not always positively correlated with the stock market.
Although this gives some indications and signals about the stock market trend because it is called a leading indicator, yet the signals which are formed by it show errors. According to the technical analysts, signals will always show some errors in them and complete accuracy can never be predicted.
4. Breadth of the Market:
This indicator measures the strength of declines or advances in the stock market. The techniques and tools measure the stocks are yielding high profits and in finding out how often the stock prices are changing their movements.
The breadth of the market is calculated by subtracting the number of issues whose prices have increased or advances that is by measuring the volatility by stock prices. This is also referred to as plurality. This measures the breadth of the market.
If the breadth becomes negative the technical analyst feels that the speculator should not think that this is a negative direction. The measurement of the breadth of a market depends only on the direction which is taken or shown by the breadth. Line charts are used to show the breadth of the market.
The indication that is shown by the breadth in a downward period is that the prices of known shares and risky shares are falling but the prices of growth and income shares called blue-chips are stable or even rising but downward trend shows that the market is weak and there is a signal that the prices in the market are falling.
The breadth of the market moves in the same direction as the market average. The market advance line would show optimism in the market.
5. Relative Strength:
Relative strength is the technical name which technical analysts have formulated to show that those securities which have continued to be stable historically in the past will give an investor a higher return because the security has stability and is able to withstand both the depression and peak periods.
According to the analysts, the investor should make a choice of investing in those securities which have constant strength in the market. This can be done by comparing the prices of those securities which rise and fall faster than the price of other securities. One of the technical analysts Levy suggests that all stocks do not move with prices in the same manner, some move in both directions faster than the other.
Some securities move in the same manner showing strength and stability of securities. These are the securities that an investor should plan to purchase.
The relative strength market has been applied to measure an individual security or future securities in industries. But this method is not useful for making a market analysis.
The relative strength can be calculated:
(i) By measuring the rate of return of securities,
(ii) By classifying securities,
(iii) By finding out the high average return of securities,
(iv) By using the technique of ratio analysis to find out the strength of an individual security. Technical analyst measures relative strength as an indication for finding out the returns of securities.
According to them, those securities which have relative strength show high returns in bull markets but not in the bear markets, that is, that when the market is falling these securities show weakness when compared to similar securities in the industry.
Those securities which are encompassed by systematic risk will be highly volatile, i.e., that they will rise and fall faster than the market because risk covering them cannot be diversified. Relative strength is thus explained by technical analysts as a relationship between risk and return of a security following the trends in the economy.
Another indicator according to the technical analysts to find out the behaviour of stock prices in the market is by checking the daily list of stock exchange quotations. This index is generally on market condition and measures the intensity with which the investors purchase or sell the security.
The volume according to the technical analysts measures the intensity of the emotion of the investor. The technical analysts who measures the volume of trading of stocks is careful in watching the demand and supply of securities whenever there is a change in equilibrium.
When the prices move up and fall this reflects and also shows an upward trend then it is a signal that the market is operated by bulls. A high trading volume in the share market when prices are falling indicates that the volume of trading shows a bear’s signal.
The technical analysts believe that when the volume of purchase and sale is high but the prices are falling, then bullish market can be considered to have come to an end and the market operating for bears is close at hand.
When the volume of selling is shown by liquidation of stocks by investors it is called a “selling climax.” This climax eliminates the bears and clears the market. It shows that the market for the bears is at end and the trends are for a rise in the market.
Technical analysts also mark the bull market is at an end through a ‘speculative blow off. When the volume of purchases is maximum and the price is also very high then the bullish speculators come to an end and pave the way for the bears to walk into the market.
This is called the speculative blow off, that is the death of the bull market with a loud sound and change towards bear market as the bull market is completely exhausted.
6. Moving Average Analysis:
The technical analyst also forecasts the price of shares by using the statistical method of moving averages. The moving averages smoothen the daily fluctuations and show the trend for individual securities as well as for market indexes.
The analysis of moving averages is the incorporation of signals which are made through penetration. Moving averages, as discussed, show daily prices. When these show a continuous fall there is a downward penetration and it is a sign to sell, when the prices are moving above the moving average line but falling the differences is said to be narrowing thus showing that the bull market is at an end.
According to the investors, the stocks should be purchased by a speculator when the moving average is flat and the stock price rise through moving average.
According to the analysts, if the prices of stock shown on the line indicate that they are below the moving average line which is rising, the speculator should also buy when the stock price is above the moving average line but it is falling and turning around and again begins to reach a higher place before it reaches the moving average line.
The technical analysts also extend opinion that speculators should sell the stock when the moving average line is flat and the stock price are below the moving average line. They should also sell when the stock prices rise above the moving average line which is declining. Again when the stock prices fall downward but turns to rise, falling again before it reaches the moving average line.
The moving average trend is quite a useful method in finding out the trends in security prices when it is based on long-term approach. But these results are not always correct and technical analysts are usually true to only a certain extend but not mathematically accurate.
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