Over-the-counter (OTC) stocks are not traded on a public exchange like the New York Stock Exchange (NYSE) or Nasdaq. Instead, these stocks are traded through a broker-dealer network. Additionally, the over-the-counter market can also include other types of securities. The Financial Industry Regulatory Authority regulates broker-dealers that engage in OTC trading.
For investors, it can be important to understand the meaning of OTC stocks, and where these securities might fit into your portfolio before trading them.
What Are OTC Stocks?
As mentioned, an OTC stock is one that trades outside of a traditional public stock exchange. As such, in order to grasp OTC stock trading and how it works, it helps to have a clear understanding of public stock exchanges.
A stock exchange — like NYSE or Nasdaq — is a regulated environment in which buyers and sellers can trade shares of publicly listed companies. Before a stock can be listed on an exchange for public trading, it first has to meet the guidelines established by that exchange (for example, a company that wants to be listed on the Nasdaq must meet the Nasdaq listing requirements).
Companies may opt to trade shares in the over-the-counter market (meaning, they trade through a broker-dealer) if they’re unable to meet the listing requirements of a public exchange. OTC trading may also appeal to companies that were previously traded on an exchange but have since been delisted.
Also, stocks that are traded on an exchange are called “listed stocks,” while those that trade OTC are often called “unlisted stocks.”
💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.
How to Buy OTC Stocks
Investors interested in purchasing OTC stocks may not need to change their investing strategy much, because depending on the exchange or platform they use to buy listed investments, they may be able to buy OTC stocks in much the same way.
Again, this will largely depend on the platform being used, but many — but not all — exchanges or platforms allow investors to trade OTC stocks. This can be done by searching for the OTC stock on the platform and placing an order. Investors may need to know the specific stock ticker they’re looking for, however, so there may be a bit of initial homework involved.
Types of OTC Securities
OTC trading tends to focus on equities, i.e. stocks. In fact, it’s even common to see penny stocks being traded over the counter, or used as a common example of an OTC security. But stocks don’t make up the entirety of OTC trading activity. Other types of investments that can be traded OTC include:
• Derivatives
• Corporate bonds
• Government securities
• Foreign currency (forex)
• Commodities
Altogether, there are thousands of securities that trade over the market. These can include small and micro-cap companies, large-cap American Depositary Receipts (ADRs), and foreign ordinaries (international stocks that are not available on U.S. exchanges). Companies that trade over the counter may report to the SEC, though not all of them do.
Types of OTC Markets
In the U.S., the majority of over-the-counter trading takes place on networks operated by OTC Markets Group. This company runs the largest OTC trading marketplace and quote system in the country (the other main one is the OTC Bulletin Board, or OTCBB). While companies that trade their stocks on major exchanges must formally apply and meet listing standards, companies quoted on the OTCBB or OTC Markets do not have to apply for listing or meet any minimum financial standards.
OTC Markets Group organizes OTC stocks and securities into three distinct markets:
• OTCQX
• OTCQB
• Pink Sheets
OTCQX
OTCQX is the first and highest tier, and is reserved for companies that provide the most detail to OTC Markets Group for listing. Companies listed here must be up-to-date with regard to regulatory disclosure requirements and maintain accurate financial records.
Penny stocks, shell corporations, and companies that are engaged in a bankruptcy filing are excluded from this grouping. It’s common to find stocks from foreign companies (e.g. foreign ordinaries) listed here.
OTCQB
The middle tier is designed for companies that are still in the early to middle stages of growth and development. These companies must have audited financials and meet a minimum bid price of $0.01. They must also be up-to-date on current regulatory reporting requirements, and not be in bankruptcy.
Pink Sheets
The Pink Sheets or Pink Open Market has no minimum financial standard that companies are required to meet, nor do they have reporting or SEC registration requirements. These are only required if the company is listed on a Qualified Foreign Exchange.
Be forewarned: OTC Markets Group specifies that the Pink Market is designed for professional and sophisticated investors who have a high risk tolerance for trading companies about which little information is available.
💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.
Pros and Cons of OTC Trading
Investing can be risky in general, but the risks may be heightened with trading OTC stocks. But trading higher risk stocks could result in bigger rewards if they’re able to produce above-average returns.
When considering OTC stocks, it’s important to understand how the positives and potential negatives may balance out — if at all. It’s also helpful to consider your personal risk tolerance and investment goals to determine whether it makes sense to join the over-the-counter market.
|
Trading OTC Stocks: Pros and Cons |
|
|---|---|
| OTC Stock Trading Pros | OTC Stock Trading Cons |
| Over-the-counter trading may be suitable for investors who are interested in early stage companies that have yet to go public via an IPO. | Micro-cap stocks and nano-cap stocks that trade over the counter may lack a demonstrated track record of positive performance. |
| Investing in penny stocks can allow you to take larger positions in companies. | Taking a larger position in a penny stock could amplify losses if its price declines. |
| May appeal to active traders who are more interested in current pricing trends than fundamentals. | Limited information can make it difficult to assess a company’s financials and accurately estimate its value. |
| Trading cryptocurrency on an OTC exchange could help minimize hacking or security risks. | OTC securities are subject to less regulation than stocks listed on a public exchange, which may increase the possibility of fraudulent activity. |
| OTC trading makes it possible to invest in foreign companies or companies that may be excluded from being listed on a public exchange. | OTC stocks may be more illiquid than stocks traded on a public exchange, making it more difficult to change your position. |
The Takeaway
OTC stocks are those that trade outside of traditional exchanges. Since OTC stocks trade outside of traditional exchanges like the NYSE or Nasdaq, the OTC market gives you access to different types of securities, including penny stocks, international stocks, derivatives, corporate bonds, and even cryptocurrency.
If you’re interested in OTC trading, the first step is to consider how much risk you’re willing to take on and how much money you’re willing to invest. Having a baseline for both can help you to manage risk and minimize your potential for losses.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
How do OTC stocks differ from stocks listed on major exchanges?
The primary difference between OTC stocks and stocks listed on major exchanges is exactly that: OTC stocks aren’t not listed on major U.S. stock exchanges. They can still be traded, however, but how they’re listed (or not listed) is the primary differentiator.
How can I buy or sell OTC stocks?
Many investors can use their preferred brokerage or platform to buy and sell OTC stocks. Not all brokerages or investment platforms allow investors to do so, but many do, and trading them often involves searching for the appropriate ticker and executing a trade.
Are there any specific regulations or reporting requirements for OTC stocks?
There are reporting standards for OTC stocks, but those standards are not as stringent as listed stocks. Depending on the OTC market on which an OTC stock trades, more or less reporting may be required.
What are the main factors to consider when researching OTC stocks?
Investors should consider many factors in the OTC market, but among them are volatility, liquidity and trading volume, and applicable regulations. These three factors may have the biggest impact on how an OTC stock performs going forward, though that’s not guaranteed.
Are there any restrictions or limitations on trading OTC stocks?
Not really, other than an exchange, brokerage, or platform perhaps not allowing users or investors to trade OTC stocks or securities. In that case, investors can look for another platform on which to execute trades that does allow OTC trading.
Photo credit: iStock/JohnnyGreig
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