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Over-the-counter (OTC) stocks are those traded but not listed on a formal exchange. Listed companies in the U.S. are traded on the NYSE (New York Stock Exchange) or the National Association of Securities Dealers Automated Quotation (NASDAQ). OTC stocks are traded through a broker-dealer.
OTC stocks are also commonly called “penny stocks” because they typically trade for $5 per share or less, often trading for under $1 per share. OTC stocks are a bargain as it’s possible to acquire a lot of shares for a small amount of money. If the stock is a winner, it’s possible to see a return many times over.
However, OTC stocks have some potential drawbacks too. As they aren’t frequently traded, they offer a low level of liquidity. OTC markets don’t have the oversight or conditions that major exchanges have. Because many companies that trade OTC stocks don’t have a long history, you also won’t find a lot of information when researching potential stocks.
This article discusses the details you need to know when considering OTC stocks.
Understanding OTC Stocks
OTC stocks don’t have to meet the listing requirements for major exchanges, including minimum share price, a certain number of outstanding shares, minimum market capitalization, financial reporting, and a minimum level of financial health.
The NYSE requires companies to have at least 1.1 million outstanding publicly traded shares and a collective market value of at least $40 million. The NASDAQ requires 1.25 million publicly traded shares with a collective market value of at least $45 million, and both exchanges require a minimum listing price of $4 per share.
Both exchanges also require initial and yearly listing fees. The fees depend on the number of shares being traded and can total hundreds of thousands of dollars. NYSE fees are considerably higher than NASDAQ fees, but both can be out of reach for small or new companies.
OTC markets allow stocks that don’t meet these requirements to be listed and traded. Within the OTC Market Group, there are different tiers where OTC stocks are traded; OTCQX, OTCQB, and Pink Open Market, also known as Pink Sheets.
OTCQX is the highest tier of OTC Markets’ securities. Companies must be current on regulatory disclosures, provide audited financial statements, and cannot be a penny stock, a shell corporation, or currently in bankruptcy.
OTCBQ is for new and growing companies. Stocks traded here must have a bid price of at least $0.01, be current on their regulatory disclosures, have audited financial statements, and not currently be in bankruptcy.
There are no minimum financial standards in this tier, and companies are not required to disclose financial information.
Where to Find OTC Stocks?
- TD Ameritrade: $6.95 per OTCBB trade
TD Ameritrade is a stockbroker founded in 1971. The company offers an electronic trading platform for various financial assets, including OTC stocks. TD Ameritrade takes orders for OTC stocks listed on the OTC Bulletin Board and Pink Sheet securities. There is no minimum to open an account. A mobile app is available for both iPhones and Androids.
- Charles Schwab: $6.95 per OTCBB trade
Charles Schwab is a stockbroker founded in 1971. It’s possible to trade OTC stocks, among other assets, via Schwab. Charles Schwab takes orders for OTC stocks listed on the OTC Bulletin Board and Pink Sheet securities. There is no minimum to open an account. A mobile app is available for both iPhones and Androids.
- TradeStation: $0 per trade (up to 10,000 shares)
TradeStation is an online securities trading firm founded in 1982. TradeStation offers a service called TS Select for trading OTC stocks commission-free and is available via their web platform or mobile app. There is no minimum to open an account.
- Interactive Brokers: $0.0035 per share
Interactive Brokers is a brokerage firm founded in 1978 and is the largest electronic trading platform in the U.S. by the number of daily revenue trades. You can trade OTC stocks with Interactive Brokers with additional permission. From the company’s website, “Before you can trade penny stocks, you must request penny stock trading permission.” You must read the penny stock disclosure and use two-factor authentication to be eligible to trade OTC stocks on the platform. There is no minimum to open an account.
- Fidelity: $0 per trade
Fidelity is the largest U.S. brokerage firm; founded in 1946, the company has $4.3 trillion in assets under management. You can trade OTC stocks with Fidelity after reading a disclosure. There is no minimum to open an account.
Researching OTC Stocks
As with any stock, it’s crucial to research OTC stocks before spending money on them. There are two categories of U.S. companies that tend to trade OTC; established companies that are having financial difficulties and new companies looking for capital to help them grow. Some established international companies sell shares via OTC markets in order to reduce their regulatory burden but must adhere to the reporting standards required in their home countries. Researching companies that fall into one of these three categories can help identify potential OTC stocks to add to a portfolio.
Once you have a list of potential OTC stocks to consider, evaluate each company’s financial health and fundamentals just as you would with any stock you were considering. Consider market trends and news related to the stocks on your potentials list.
There are online tools and resources that can make your research easier, including stock screeners, market scanners, and news alerts. These tools allow you to filter and sort a lot of data quickly and find the most relevant information to help you make an informed decisions.
Risk Management and Trading Strategies
All stocks have a risk/reward balance, and the holy grail is creating a strategy that limits risk as much as possible while still making the potential returns worthwhile.
Because OTC stocks are less liquid than many other assets due to their low trading volume, any money allocated to them should not be money you may need in the near term. And because OTC stocks represent a higher risk than some other types of assets, any money spent on them should be your “gambling” money, your high-risk money that you can afford to lose. And determine how much you’re willing to lose on each trade.
A solid trading strategy takes into account your risk tolerance, trading style, and expectations. Having a strategy in place helps you avoid rash decisions which often hurt your portfolio. A trading strategy should include:
- Goal: What are you hoping to get out of this trade?
- Risk: What is your level of risk tolerance?
- Research: Research can help you assess how a stock will perform. You can never be 100% certain, but thorough research can help avoid investing mistakes.
- Entry and Exit Plan: Make a plan for entering and exiting each trade. Decide what are the “go” signs to buy and what you will do if a trade starts going bad.
OTC stocks are not winning lottery tickets where one right pick will result in a big win. They can offer significant returns because, with the low price, even a small percentage increase in a stock’s value can mean a substantial return, but that doesn’t necessarily mean a lot of money.
Don’t fall into the trap of being sure you’ve found a hidden gem that will surely be the next Game Stop situation. That sort of thing is a rarity, and there was a perfect storm of events that made it possible. Always stick to your trading plan, which helps prevent trades based on emotion.
Ongoing Monitoring and Portfolio Management
What gets measured gets managed, so monitoring and tracking your OTC stocks is essential. There are a number of trackers and services that give you an overview of your portfolio so you can see all of the information at a glance.
Identify your exit points for both profit and loss on each of your stocks and stick to them as part of your overall trading plan. You created the plan without emotion, and it needs to be executed without emotion.
OTC stocks can be volatile and require regular reviews so you can adjust your positions so they continue to fit your overall investment strategy.
Typically, when you sell stock, you have to pay capital gains taxes on any gain in value the stock has had in the time you’ve owned it. If you hold a stock for a year or more, you pay tax at the long-term capital gains rate based on your income bracket. If you’ve owned a stock for less than a year, you pay the ordinary income tax rate, which is higher than the long-term capital gains rate.
If you’re acquiring OTC stocks hoping for a quick gain, you may not own it long enough to meet the long-term capital gains rate, which means you’ll pay more in taxes on any earnings. This needs to be taken into account for each OTC stock you are considering, as the tax burden could negate any gains a stock has made.
It’s important to keep current on any regulatory changes and compliance requirements when it comes to your stocks. This can be difficult for those new to OTC stocks, so it can be helpful to work with a financial professional or to seek the advice of investors who have experience with OTC stocks.
OTC stocks are not sold on the major exchanges but through brokers and are not regulated the way listed stocks are. Because OTC stocks are considered high-risk, it’s vital to do a great deal of research, create a trading plan, and monitor individual stocks and your overall portfolio.
What are OTC stocks?
An OTC stock is a stock that is traded on the OTC markets and not listed on the major U.S. exchanges.
Where can I acquire OTC stocks?
You can acquire OTC stocks through online trading platforms, including TD Ameritrade, Charles Schwab, TradeStation, Interactive Brokers, and Fidelity.
What are the risks of OTC stocks?
There is less information about OTC stocks than there is for other types of stocks, which makes researching them more difficult. OTC stocks are considered an ill-liquid. OTC stocks have a low trading volume which can increase volatility. OTC trading has less regulation than trading through the major exchanges. OTC stocks are vulnerable to “pump and dump” schemes in which a fraudster spreads false or misleading information, frequently via social media, to create a buying frenzy for a stock to artificially pump the price up and then dump their own shares, selling them at the inflated price.
What are the potential benefits of OTC stocks?
It is possible to find an up-and-comer stock and buy a lot of shares early on. Because OTC stocks are inexpensive, your money could go further than it does with other types of investments.
What time does the OTC market open?
OTC market operates on the same hours as the listed exchanges, opening at 9:30 a.m. Eastern and closing at 4:00 p.m. Eastern.
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