Most retail investors who buy and sell stocks purchase securities through a broker. And consumer facing retail brokerages often serve as a platform for stocks that are listed on a publicly traded stock exchange, like the NYSE or NASDAQ. But what about buying and selling stocks of companies not listed on these exchanges?
How to Buy OTC Stocks
- Pick a Broker
- Open an Account
- Place a Bid
- Rinse and Repeat
When it comes to prescription medication, over the counter refers to drugs or other such palliatives that you don’t need a prescription for. In a sense, that makes them easier to get because you don’t need a prescription from a doctor.
It’s the opposite, so to speak, when it comes to Wall Street and stock investing. OTC or over the counter stocks are not traded on public exchanges, and as such, most consumer facing brokerages aren’t able to facilitate transactions of OTC securities. In this sense, they are harder to get—but not impossible. In fact, it’s totally within the reach of the average retail investor to purchase OTC stocks.
But first, we should examine what exactly it is about OTC stocks that makes them different.
What Are OTC Stocks?
OTC stocks are almost always going to be penny stocks, which means that each share of stock is worth less than $1. Companies offering OTC stocks usually have a market capitalization of less than $50 million.
Market cap (as it’s called for short) represents the market value of a company’s outstanding shares of stock (both those available for sale and those held by investors—both retail investors and institutional investors). To give you a sense of the market cap of well-known companies publicly traded on a regulated stock exchange, at the time of this article Apple (NASDAQ: AAPL) has a market cap of $2.84 trillion, Amazon (NASDAQ: AMZN) has a market cap of $1.78 trillion, JP Morgan Chase (NYSE: JPM) has a market cap of $479.55 billion, and Disney (NYSE: DIS) has a market cap of $276.68 billion.
The fact that OTC stocks have a market cap of less than $50 million should now put things in perspective. Remember that companies sell shares of stock to (typically) raise money for operating or expanding their business—whether that means expanding into new territories or even new enterprises. A company with a market cap less than $50 million could certainly be larger than a mom-and-pop retail store, but it’s not as large as an established company that is branded and cemented in consumer lexicon.
OTC stocks are often issued by companies that are in the startup or early growth stages of development. They may be on the cusp of developing a new product, technology, or medical cure. However, the payout of their research and development is still very much—as they say in Latin—in potentia.
This means that OTC stocks represent a possible financial windfall. However, most OTC stocks are not going to turn into a jackpot. They will continue to bounce around the dollar range. Many of the companies may even go bust. For this reason, OTC stocks are much more of a gamble than securities purchased on a regulated stock exchange, like the aforementioned NYSE or NASDAQ, or even a foreign stock exchange.
This doesn’t mean that OTC stocks are inherently, by nature, the same as gambling in a casino. At the same time, while there is a difference between gambling vs. investing, OTC stocks present a significant amount of investment risk, especially for the average consumer who does not know how to use trading tools like short selling and options contracts to hedge their losses.
What is the Difference Between OTC and a Stock Exchange?
Stock exchanges offering securities for sale to the general public have tight listing requirements around accounting and transparency. These requirements are promulgated and enforced by the SEC (Securities and Exchange Commission), a branch of the federal government established after the 1929 stock market crash to prevent market manipulation.
Prior to the advent of the SEC, unscrupulous investors (both powerful individual investors along with banks and companies) could engage in schemes to manipulate the stock market for personal benefit. These days, the SEC prevents (or at least tries to prevent) pump and dump schemes, insider trading, and other market manipulations that destroy consumer confidence in the stock market. If the everyday investor did not feel comfortable putting their money in the stock market, it would not only be a problem in terms of entrepreneurial spirits seeking to ride the waves of the market; it would likely prevent people in the workforce from willingly participating in a retirement plan comprised of mutual funds or company stock.
As mentioned, though, OTC stocks are not sold on a stock exchange. For whatever reason, they may not wish to comply with strict SEC guidelines around transparency, such as compilation of two annual reports—one to the SEC, and one to shareholders. This is not to say that the company is attempting to conduct business dishonestly, they just may not have the bandwidth to prepare extensive reports on their profits, losses, and business activity.
Additional SEC requirements include predictable and consistent revenue, cash on hand to fund the IPO (initial public offering), growth potential in their sector, and competent management with a plan for corporate governance. Companies in the startup or growth stages of development may not meet these requirements. And sometimes, a company that was publicly traded will fall out of being able to meet these requirements, returning to OTC status.
Where Are OTC Stocks Traded?
Unlike the major stock exchanges, OTC stocks are traded over a dealer-broker network. For years, the two venues for facilitating the trade of OTC equities are typically the Over the Counter Bulletin Board (OTCBB) or the Pink Sheets Listing Services.
The OTCBB was an electronic quotation service created by the Financial Industry Regulation Authority (FINRA). Because it only provided quotes, brokers and dealers still needed to negotiate with each other over the phone or via a computerized network. Once most OTC stock transactions started trading on electronic platforms managed by OTC Markets Group, FINRA closed the OTCBB in 2020.
Pink Sheets often refers to OTC Pink, now referred to as the Pink Open Market. The Pink Open Market is also managed by OTC Markets Group, but of the three operating OTC marketplaces out there, it is regarded as the most speculative because there are almost no disclosure requirements for the stocks traded thereon. If you’re wondering where the name comes from, it comes from the fact that information about each stock was formerly printed on pink sheets of paper. While those sheets are now gone, the name stuck around.
The other two OTC trading marketplaces that are managed by OTC Markets Group Inc are OTCQX and OTCQB. Take note that in addition to the fact that the third most unregulated platform for OTC penny stocks is called Pink, the OTC company as a whole was (and is) referred to as Pink Sheets—again because the trading information facilitating stock trades used to be printed on pink sheets of paper.
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OTCQX vs OTCQB Exchanges
OTCQX is a formal exchange with requirements that are not as tight as the SEC and the New York Stock Exchange, but it does have some requirements. This is where a foreign company would get itself listed to find American traders willing to provide capital to the company in search of capital. These companies must go through an analysis by OTC Markets Group and post their financial information. Additionally, they cannot be going through bankruptcy, nor can they be a shell company.
The OTCQB venue offers OTC shares of companies that are verified and approved by the OTC Markets Group. Additionally, their OTC shares must have a valuation of at least one penny per share. The companies need to pay a $12k annual fee to participate in this particular OTC market. In some states there are Blue Sky laws that an unlisted stock (that is, a stock not listed on a major public marketplace) must follow, which often include transparency, disclosure, and reporting of their financial state. These laws are meant to protect consumers from trading stocks that are excessively volatile or subject to potentially fraudulent activity, in part to facilitate the lack of transparent disclosure regarding the stock.
In summary, the traditional stock exchange markets have tight requirements for the participation of listed companies in order to create a stable (as possible) marketplace that breeds consumer confidence in the idea of investing in stocks. By comparison, OTC stock networks are sort of the Wild West, albeit one where certain parts are more lawful than others (by which we mean that certain markets have tighter disclosure requirements than others).
Both types of markets operate with the assistance of market makers like dealers and brokers, or allow for stocks to be bought and sold over electronic boards. However, the stocks listed on a public exchange are easier to find for consumers because they are available for purchase through brokerages like the ones offered by your bank or popular trading apps like Robinhood.
How to Buy OTC Stocks
Now that we’ve gone over what OTC stocks are and how they are typically sold, let’s go over the process of investing in them:
1. Pick a Broker
Do you know a stock broker in your personal network? A true stockbroker needs to take a Series 7 and Series 63 licensing exam, though they do not necessarily need to work with an investment firm. In any case, such a stockbroker can be a personal point of contact for purchasing OTC stocks and navigating that process for you (which may include, for example, getting on the phone to directly negotiate a transaction or using an electronic trading board).
However, there are ways for the average retail investor to buy and sell OTC stocks on their own. TradeStation, Zacks, and Interactive Brokers are a few trading platforms that offer OTC stocks. Most major banks will not facilitate OTC trades for their customers, however TDAmeritrade and Fidelity do. Robinhood does not support OTC trades.
Keep in mind that many OTC stocks are penny stocks. Many brokerages that facilitate retail investors placing their own trades do support a decent number of penny stocks, including Robinhood. Even though these securities are priced under $1 (in some cases, under $5 or $10), they do meet the SEC requirements for being publicly listed. You cannot place the trades yourself on any of the three OTC markets discussed above;you need a FINRA registered broker-dealer to do that for you.
When you place OTC trades on the consumer facing brokerages like Zacks or Fidelity, they place these trades on your behalf (just like they do with publicly traded securities).
2. Open an Account
The next step, of course, is to open an account. Trading platforms like Zacks are free to use and place trades on, however, they do charge commissions. Keep in mind that because OTC stocks are priced so low, in order to see any financial benefit from their activity, you will often have to place trades in large volumes, which means paying more commissions. However, the cost of these commissions is often very negligible.
For instance, Zacks charges just one penny for stocks priced above $1, while charging only one percent for stocks below that threshold. Many of these platforms do have ancillary services and tools like a stock screener for conducting research, and these tools are provided as part of a paid subscription service. Some of the basic tools, such as a stock dividend calculator are typically free.
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Once you’ve picked your broker and opened an account, it’s time to start doing your research. Unfortunately, most retail investors are not trained on how to perform fundamental analysis of a company offering a stock—that is, taking a look at its finances, debt, management, operations, and market share, along with growth potential. To make matters worse, remember that OTC stocks are not required to offer the same level of transparency provided by a publicly listed company. Moreover, an investor looking to capitalize on the market movements of OTC stocks is somewhat out of luck. This is because profiting on market movements can (in most cases) really only be facilitated by reading information provided by algorithmic analysis. If you can’t code your own software to do that, you will have to pay for it. And most of the ones you can pay for only look at certain securities because they need to have a certain amount of information in order to make projections.
All that to say, investing in OTC stocks can be a shot in the dark for many aspiring investors. There’s only so much you can do in terms of research. Just remember that most penny stocks are not going to “go to the moon,” and you should avoid placing more than five percent of your investment portfolio into such activity.
4. Place a Bid
Since you cannot place the trades yourself on any of the three OTC marketplaces, you won’t actually be doing real, on-the-ground bidding. However, whether you do so through your broker or on the investing platform you’ve selected, you will likely have the option of directing how much you are willing to pay for a given security.
A market order means purchasing the stock at whatever price is listed on the market. A limit order means you will only purchase the stock when it hits a certain price. You can input these directions on the trading platform or give them to your broker. Just remember that lower priced securities can be particularly volatile, so placing limit orders can be a way to put your investing on autopilot without paying more than you’re comfortable with while minimizing your potential losses.
It’s also important to keep in mind that just because the market cap of OTC stocks is small, doesn’t mean they have a much lower degree of liquidity than typical stocks traded on a public exchange like the NYSE or NASDAQ. This can make it harder to buy the OTC stocks you want, and harder to sell the ones you’d like to get rid of because there are fewer buyers and sellers working in the marketplaces.
5. Rinse and Repeat
In any case, if you’ve found an OTC stock that you want to buy and sell to capitalize on price swings, you can repeat the action as needed. And if you’ve developed a good sense of which OTC stocks stand a viable chance of progressing into something more, you can repeat that process to build a steadily growing portfolio.
Fair warning: most retail investors are going to find their experience with OTC stocks to be (at worst) frustrating and (at best) nothing more than something like visiting a casino. If the idea of investing in up-and-coming companies appeals to you, but the volatility and unpredictability of OTC stocks is not appealing, you might consider using a trading app that gives access to pre-IPO companies. These companies do meet the SEC requirements for being publicly listed, which means they are more transparent, more stable, and less risky than OTC stocks.
If your brokerage offers these pre-IPO opportunities, you can read about the company and get a better sense of what they do and where they could go. However, these companies are not going to sell shares for pennies, nickels, or dimes. Typically, their IPO price might be anywhere from $10 to $100.
How to Sell OTC Stocks
The process for selling OTC stocks is similar to buying them. Namely, you will just place trades on the online platform you’re using, or tell your broker to unload them.
Again, remember that the small market cap of these stocks means there are fewer potential buyers, and you may be stuck with them longer than you would like. The lower frequency of trading volume is just part and parcel of dealing with a security not listed on a major exchange, in addition to the volatility of its stock price. This means, for example, that by the time you have located a buyer for exchange trading, the share price may have decreased to the point that your trade is no longer profitable. For all these reasons, it may be best to work with someone who understands the ups and downs of stock trading a microcap stock instead of just relying on an interactive broker provided by a platform like Zacks or TD Ameritrade.
OTC Trading Can Be Volatile, So Proceed with Caution
OTC trading isn’t for everyone. At the same time, there are plenty of OTC stocks that are foreign companies that could present significantly stable, forward-thinking investments. They’re just not a listed stock on the NYSE or NASDAQ because they don’t meet the requirements of the SEC and/or those particular marketplaces.
At the same time, most OTC stocks are penny stocks that are trading in low volume (making them illiquid) and represent companies that are in the early stages of development (making them more volatile). In some cases, such as the Pink Market, the lack of required reporting in regards to transparency may even facilitate unscrupulous companies, such as those that violate patent law by selling items in the grey market.
If the excitement of making a lot of money on a company at the cusp of some miracle cure or world changing tech development is appealing to you, that’s something you can still do. You just need to learn to minimize your risk, while maximizing your opportunity—and that’s something you can learn more about by signing up for a free Infinity Investing Membership and joining one of our weekly Stock Investing Rooms.
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