Insider Trading

Insider trading is the purchase and sale of shares held by corporate officers, directors, and owners of 10 percent or more of a company’s securities. Corporate directors, officers, and large shareholders— referred to as insiders—have access to privileged information about their companies and therefore are required by the Securities and Exchange Commission (SEC) to report their purchases and sales of stocks. Insiders know first-hand how their companies are doing; if they are purchasing their company’s stocks, it is a bullish signal for those stocks. Conversely, if insiders sell their stocks, it is a bearish signal.

You can follow insider transactions in the financial newspapers and on various Web sites. Many technicians follow insider activity as a method for selecting stocks. Academic studies tend to lend more support to insider transactions than to other technical approaches as a means of correlating changes in stock prices (Jaffe, 1974, pp. 410–428; Zweig, 1976, p. 5).

Odd-Lot Theory

The odd-lot theory states that investors should make investments contrary to those made by individual investors who invest in odd-lot orders of stocks. The odd-lot theory is concerned with the purchase and sale of securities by small investors. An odd-lot trade consists of fewer than 100 shares and is generally placed by individual investors who are considered to be unsophisticated. When “odd-lotters” are purchasing stocks, it is a sign to sell stocks. Similarly, when “odd-lotters” are selling stocks, you should buy stocks according to the odd-lot theory. Small investors are frequently wrong in their investment decisions. This type of investor is viewed as uninformed about the workings of the market. According to the theory, these small investors typically buy stocks at the peak of a bull market, which is when astute investors (advocates of this theory) start selling. Similarly, after a stock market decline, the time to buy is when small investors are bailing out of their stock positions.

TheWall Street Journal reports odd-lot trading on a daily basis, and Barron’s reports it on a weekly basis. Technical analysts calculate the ratio of odd-lot purchases to odd-lot sales, which has a typical range from 0.6 to 1.4.

Odd-lot ratio = odd-lot purchases/odd-lot sales

A ratio that is approaching its upper limits (1.4) means that small investors are buying more than they are selling. This situation indicates that the stock market is about to turn and become a bear market. In other words, small investors become enthusiastic about the stock market when the market has reached its highs and become disillusioned after a crash in the market, which gives a low reading on the ratio. This is a contrarian indicator (going against the crowd; buying when the majority of investors are selling and selling when the majority of individual investors are buying).

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