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The 1 Risk You Must be Aware Of With The Smaller Lot Size In Singapore’s Stock Market

On a 22 April 2015 webcast, Magnus Bocker, the outgoing Chief Executive Officer of Singapore Exchange Limited (SGX: S68), made a landmark declaration: The reduction in the board lot size for the SGX has worked.

For those unaware, Bocker was referring to the monumental change in the standard board lot size in Singapore’s stock market from 1,000 units to 100 units on 19 January 2015.

The before-and-after stats for the lot size change is persuasive: 54% of trade orders in the first-quarter of 2015 were for lot sizes below 1,000 units while daily trades for the 30 constituents of the Strait Times Index  (SGX: ^STI) rose by 56% quarter on quarter.

These figures are impressive. But what really made me sit up and take notice is this: The number of trades made had spiked by 104% quarter on quarter. I’m singling this statistic out because within it lies an important risk about the smaller board lot size which you should know.

With great power comes great responsibility

Entering a trade order for a stock today has never been easier. There are mobile trading apps which gives the common investor the convenience of purchasing stocks with just a few taps on their smartphone.

At the same time, the smaller lot size in Singapore’s stock market also means that lower amounts of cash and commissions are involved, thus making it cheaper to trade stocks.

But the thing is, when it is cheaper and more convenient to trade, the likely outcome could be more trading in an attempt to time the little gyrations in the market.

Timing the market, though, may not be a wise move as my colleague Ser Jing has pointed out previously. The chart below plots the annual returns of the S&P 500 (a broad U.S. market index) against its starting valuation for a one year holding period using data that stretches from 1871 to 2013.

Chart 1 - Average annual returns of S&P 500 for 1 year holding period

Source: Robert Shiller; Ser Jing’s calculations

As you may have guessed, the chances of turning in a decent return within a short one year period is akin to throwing spaghetti on the wall and hoping it sticks. In other words, it may not end well for the common investor (no spouse will want a spaghetti-filled wall either!).

Chart 2 - Average annual returns of S&P 500 for 10 year holding period

Source: Robert Shiller; Ser Jing’s calculations

Instead, the simple act of lengthening your investing time horizon may put you in a better position to gain a decent return from the stock market. Or as Ser Jing would put it:

“When the investing time horizon’s stretched out from 1 year to 10 years, there’s now a much clearer relationship between a share’s valuation and its return – if you invest when stocks carry a low valuation, your chances of earning a good return become much higher. This is certainly not a water-tight conclusion, but it’s still very useful knowledge to have.”

A Fool’s take

In all, the smaller lot size has been a boon for the Foolish investor who is now able to purchase higher priced shares without having to fork out significant sums of money. Smaller bites of shares may even help the Foolish investor diversify his or her portfolio. All things considered, the reduction in the lot size has overwhelming benefits for the common investor.

But if the smaller lot size is used incorrectly – like for dancing in and out of shares – the positive change in the lot size may turn into a bane for the common investor. As Foolish investors, we owe it to ourselves to use the opportunity to buy shares in smaller lots wisely for the betterment of our own portfolios.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn't own shares in any company mentioned.