One question we hear time and again, is “What is the OTC Stock Market?” In this article, we will set out to address this question and help investors find out where to invest in OTC stocks.
OTC, also called over-the-counter or off-exchange trading is trades performed between two parties outside of exchange trading such as New York Stock Exchange, NASDAQ, etc. The two parties will agree on a price of the financial instrument being traded, such as a stock, bond, commodity or derivative.
OTC stocks are appealing to small companies with less than $1 million in assets because it is relatively cheap to get listed, and the regulations are less stringent. There is a wide variety of companies traded in the OTC markets. Some are well funded and have growing businesses, others suffer from poor management or lack of funding. While OTC securities do have a higher risk level than blue chip stocks, the rate of return can be multiples over any other investment. Due diligence and research are key before jumping into the OTC stock market.
OTC stock information is provided by a few inter-dealer services. Over the Counter Bulletin Board (OTCBB), http://otcbb.com,Ã‚Â and the Pink Sheets supply quote information to investors. OTCBB is operated by FINRA (Financial Industry Regulatory Authority).
OTC stocks are not traded in a formal stock exchange, but rather between individual brokers. Individuals called “Market Makers” create markets for OTC stocks by listing them on the quotation services that brokers have access to. To trade OTC stocks, you must use a broker to make the transaction. The broker can either be a physical person, or an electronic broker such as E-trade, Ameritrade, etc.
There are several levels of requirements for reporting by OTC companies. OTCBB must follow guidelines and requirements issued by the U.S. Securities and Exchange Commission (SEC). Stocks with this designation will have a .OB after their symbol.
Another type of OTC stock is called “Pink Sheets” or “Pinks”. OTC stocks with this designation will have a .PK after their symbol. These stocks have no reporting requirements, and are generally seen as less trusted for that reason. The SEC does not regulate the Pink Sheets.
Before investing OTC stocks, it is important to do thorough research and dig deep. Go tot he company website. Read their press releases. Call their investor relations phone number. Ask questions. The SEC website, http://sec.gov, will also have all of the company’s documentation and filings, including financials and statements by the management about future plans.
OTC stocks can be a risky investment, because of the small size of these companies, the lack of regulation standards and minimal public information. Some OTC stocks are also not traded that much, so you need to make sure that there is sufficient liquidity in the market in the case you would like to sell your stock.
Some of the pitfalls to watch for:
- extreme volatility in price
- small “float,” or value of shares outstanding pertaining to the company
- Fraudsters often target over-the-counter securities to manipulate them for profit. False rumors can cause OTC shares to advance sharply, before the unscrupulous “tipster” liquidates his position, in a “pump and dump” scheme.
Before putting any money in the market, whether OTC, NASDAQ, NYSE, etc., always setup a “paper trading account” and learn the ups and downs of the market through “fake” trades. This will allow you to develop your trading strategy without losing money in learning those hard lessons.