The year is 1950. It’s Christmas. Buffett is 20 years old and Barron’s publishes a letter from a “Mr. Warren Buffett, of Omaha” (I’m assuming it’s the “Mr. Warren Buffett, of Omaha” being quoted here since this was pre-Oracle of Omaha days. There’s always a slim chance another one existed, which I’ll take).
In a prior issue, Barron’s asked readers to comment on how they used the new Market Laboratory section of the paper. Fifteen people responded including Buffett. The excerpt of his letter is below (you can find the complete article at the end of the post).
Among the more interesting statistics that you publish are the figures for member trading and odd-lot trading. These two groups characteristically show a tendency to be on the opposite sides of the fence; that is, when the members are buying on balance the odd-lot traders have a selling balance, and vice versa.
The odd-lot figures must be modified to reflect a tendency for a long-term buying balance due to small investors putting away a few shares of investment stocks from time to time. Therefore the trend of relationship between odd-lot buying and selling is more important than the actual balance. When the odd-lot trader has become increasingly bullish in a rising market or increasingly bearish in a declining market, it has generally been advantageous to expect his change of sentiment to be wrong.
A recent example was the increased bearishness of the public from January to June, 1949, as the market irregularly declined to the 160 level, from which point it then climbed steadily.
From a logical point of view the theory seems to be valid, since an unsuccessful trader in stocks eventually finds his capital reduced to the point where he is forced to trade either in “penny” issues or in odd lots. On the other hand, a small successful trader will soon accrue enough profits to graduate to the round-lot class.
The other side of the picture is represented by the member trading statistics. These reflect the trading of men whose business centers about the fluctuations of stocks. It should be expected that this group as a whole will trade profitably, although some of its members natually may fail to do so.
The rise in the market that began in June of 1949 could have been foretold by a study of the members’ trading activities. The members’ trading balance had been slightly on the selling side through the early part of 1949, but during the late spring and summer their purchases began exceeding their sales by large margins, often as much as 500,000 shares a week. Although some of this undoubtedly reflected purchase of Commonwealth & Southern for its breakup potentialities, it is still apparent that there was a decided change in market sentiment on the part of the exchange members, a change just opposite to that of the odd-lot public. The members proved to be correct in their judgement while the odd-lot trader was, as usual, switching to the wrong side.
No attempt should be made to read too much into these sets of data; minor fluctuations will constantly occur that are incapable of analysis. However, when divergent trends of the two groups have appeared, it has proven profitable to trade on the side of the member and against the odd-lotter.
Basically, Buffett is describing the Odd Lot Theory. As the theory goes, the odd lotter represents the small investor since the typical small investor wasn’t buying round lots. Rounds lots are increments of 100 shares. Odd lots are anything less than the typical 100 share order.
Whether he actually traded based off this is beyond me. He would have just started at Columbia University (assuming my timeline is correct). He probably wasn’t quite married to value just yet. So it’s possible though he clearly states not “to read to much into these sets of data”. Maybe he speaks from personal experience.
Still, he figured out a basic truth of the stock market. The average investor tends to buy high and sell low. To put it more bluntly, he understood that stocks cycled from smart money to dumb money – the dumb money piles in, while the smart money gets out and vice versa – and who he should bet against. That trend hasn’t changed since.