I know I have seen this question handled somewhere before, either on this forum or somewhere else, but for the life of me I cannot seem to find it now. I have made several merchants in various Oblivion mods. There seems to be a common theme among them. For some reason, they equip whatever I sell them if it is better than what they already have. This was standard fare in Morrowind where the AI was much weaker than in Oblivion. But I don't know what I did wrong to have them doing it in Oblivion. Any advice would be much appreciated. Thanks.

The solution is simple: give the merchant a vendor container. If they don't have a container to store the stuff you sell to them, they will equip it if it is better than what they have. If you give them a container, it will wind up in their container.

The vendor container is a tab on the NPC instance, or the properties dialog for the NPC once he's placed in the cell.

I did that. I made a merchant chest, loaded it with what I want him to sell, and set it in the cell just outside the wall. I checked the Persistent Ref. box on the chest and then double clicked the merchant and went to the merchant chest tab. From there I used the select object in render window button. For some reason he still does it. Can't for the life of me figure out why.

Did you set the ownership? He has to own the chest too.