The Hustler's Digest StaffDo you want to start stock trading but are confused about the types of stocks you need to buy? Then sit back and read on to learn more about what is OTC stock and stock trading, including the types of stocks you need to buy to diversify your portfolio and get maximum returns for your investments.
A publicly traded company’s shares can be purchased and sold through stock trading. When you buy stock, you take on ownership of the business and receive a portion of its gains and losses. Stock trading aims to purchase shares at a discount and sell them for a profit.The price changes can be frequent and unpredictable on the stock market and mostly depends on economic conditions
OTC (over-the-counter) stocks are those that are not traded on well-known stock exchanges such as the New York stock or the London stock exchange. They are exchanged instead via dealer networks or alternative trading platforms. OTC stock investing may be an option for several reasons, including higher returns, portfolio diversification, and other advantages.
This article will cover details about what is OTC stock. And how to buy and sell OTC stock, including its advantages and disadvantages. It will also provide a guide on how to begin stock trading.
What is OTC stock?
OTC stands for “over-the-counter,” OTC stocks are traded through a network of dealers and brokers rather than on a centralized exchange like the New York Stock Exchange (NYSE) or the Nasdaq Stock Market. These stocks typically have a lower market capitalization than more immense, more established companies that trade on major exchanges; they are also referred to as penny stocks, micro-cap stocks, or small-cap stocks.
OTC stocks typically have a lower market capitalization than more immense, more established companies that trade on major exchanges; they are also referred to as penny stocks, micro-cap stocks, or small-cap stocks.OTC stocks can be riskier and more volatile because they do not have to face the same regulations as stocks that are listed on major exchanges.
Additionally, they need more liquidity, making it more challenging to quickly and fairly buy or sell them. Therefore, OTC stocks are more suitable for seasoned investors prepared to take on more significant risks in search of a higher return.
Example of OTC stock
The shares of a small-cap cryptocurrency company called Pinkcoin (PINK), which trades on the OTC Markets Group’s OTCQB exchange, are an example of an OTC stock. Pinkcoin also has a market cap of about $4 million as of September 2021, according to various reports.
Not all OTC stocks are speculative or risky investments; some may be shares of well-established companies that opt to trade on OTC markets for various reasons. However, OTC stocks generally have higher volatility and potential risks than those on major exchanges. Before purchasing any stock, especially OTC stocks, investors should always conduct extensive research and due diligence.
OTC trading 101: how to trade OTC stock?
When financial assets, such as stocks, bonds, or currencies, are bought and sold directly between two parties without using a centralized exchange, this is referred to as over-the-counter (OTC) trading. OTC trading is frequently used for financial instruments not traded on a public exchange or illiquid. OTC trading can occur via various methods, including phone or electronic communication.
In OTC trading, the parties to the transaction negotiate the terms of the trade, which may also include the price, the quantity, and the settlement date. OTC trading, which has more latitude for customization, can be more advantageous than trading on a public exchange, which operates under standardized rules and guidelines.
Dealers or brokers, who act as middlemen between buyers and sellers and aid in trade facilitation, may also be used in OTC trading. Financial instruments like derivatives, which can be complicated and call for a more individualized approach, are frequently used in OTC trading.OTC trading can be faster and more flexible than trading on a public exchange, but it also carries more risk because it is less regulated and transparent.
Over-the counter market examples
The over-the-counter (OTC) market is a decentralized marketplace where trading in financial instruments, such as stocks, bonds, currencies, and derivatives, takes place directly between two parties without the assistance of an exchange. Here are a few examples of over-the-counter markets
Foreign exchange (Forex) market
The Forex market is decentralized, where currencies are traded 24 hours a day, seven days a week. Trading occurs over the counter via a network of banks, brokers, and dealers.
Bond market
The OTC bond market trades fixed-income securities such as government and corporate bonds. Dealers and brokers act as go-betweens for buyers and sellers.
OTC derivatives market
The OTC derivatives market trades financial instruments such as options, swaps, and futures. Contracts are negotiated and settled privately between the parties involved.
Pink Sheets
Pink Sheet is a service that provides over-the-counter pricing and trading information. It is used for less-regulated securities that are not listed on a major exchange.
Cryptocurrency market
Many cryptocurrencies, including Bitcoin and Ethereum, are traded over the counter. Cryptocurrency exchanges and peer-to-peer transactions are used for trading.
Maximizing your investment potential: why stock trading is a crucial component of your financial strategy
Stock trading is important for several reasons:
Capital formation:
When companies issue stocks, they can raise capital to invest in their business operations. This allows them to expand and create new products, creating jobs and contributing to economic growth.
Investment opportunities:
Stock trading provides opportunities for individuals and institutions to invest in companies and earn returns on their investments. This allows individuals to grow their wealth and institutions to manage their assets.
Liquidity:
Buying and selling stocks easily and quickly provides liquidity to the market, allowing investors to access their funds when needed.
Price discovery
Stock trading allows the market to determine the value of a company’s stock based on supply and demand. This promotes efficient resource allocation and helps to create a fair price for stocks.
Information dissemination:
The stock market is a source of information about companies, their financial health, and their prospects for growth. This information is vital for investors to make informed decisions about their investments.
Overall, stock trading is an integral part of the economy and provides opportunities for companies, investors, and the general public to benefit from the growth and success of businesses.
How to buy OTC stock in 5 simple steps
Purchasing OTC (over-the-counter) stocks are similar to buying regular stocks, but there are a few distinctions to be aware of. The following are the steps to purchasing OTC stocks:
Choose a brokerage:
Not all brokerages offer OTC stocks, so you must find one that does. You can look for online brokerages that offer OTC trading or contact a local broker to see if they do.
Open an account:
You must open an account once you have found a brokerage that offers OTC trading. Typically, this entails providing personal information and funding your account.
Research the stock:
Since they are not subject to the exact regulatory requirements as regular stocks, OTC stocks can be riskier. As a result, before purchasing, it is critical to conduct due diligence and research the company and its financials.
Place an order:
Once you purchase the OTC stock, you can do so through your brokerage. You must provide the following:
- The stock symbol.
- The number of shares desired.
- The price you are willing to pay.
Monitor the stock:
OTC stocks can be more volatile and have lower liquidity, so keep an eye on the stock and be ready to sell if it falls below your stop-loss level.
It’s important to remember that investing in any stock involves risk, and OTC stocks are particularly risky. Before investing in any OTC stock, make sure you understand the risks.
How to sell OTC stock in 5 simple steps
Over-the-counter (OTC) stocks are typically sold using a broker or an online trading platform. The following are the steps to selling OTC stocks:
Open a brokerage account:
You’ll need to open a brokerage account if you don’t already have one. This can be done either online or in person with a broker.
Place a sell order:
Log in with your account and choose the OTC stock you want to sell. Then, place a sell order with your broker or online trading platform. Note the number of shares you want to sell and the price you’re willing to accept.
Confirm the order:
After you place the sell order, your broker or trading platform will confirm it. Check the order’s details carefully to ensure that everything is correct.
Wait for the order to execute:
Your sell order will be open until it is filled. This indicates that someone has agreed to purchase your shares at your specified price. The order execution time varies depending on market conditions and stock demand.
Receive the proceeds:
The proceeds of the sale will be credited to your brokerage account once your sell order is executed. The funds can then be used for other investments or withdrawn as cash.
It should be noted that OTC stocks can be more turbulent and risky than stocks traded on major exchanges. As a result, before investing in OTC stocks, do your research and understand the risks.
Exploring the pros and cons of OTC stock
OTC (over-the-counter) stocks are those that are not traded on a major exchange like the New York Stock Exchange or the NASDAQ. They are instead traded through a decentralized network of dealers. Here are some advantages and disadvantages of OTC stocks:
Pros:
Access to a broader range of companies due to which many companies are only available through the OTC market because they are not listed on major exchanges. This means that investors have more investment options.
Companies not listed on major stock exchanges are not subject to the strict regulatory requirements of listed companies. This can make it easier for small or newly-formed companies to access capital and grow their business.
It has a potential for higher returns because OTC stocks are less regulated and scrutinized. Some of these stocks have the potential for rapid growth and high returns.
Cons:
Due to a lack of information, OTC stocks are often less well-known and researched than those listed on major exchanges; there usually needs to be more information available for investors to make informed decisions.
They have greater risk because of the need for more regulation and oversight.OTC stocks are frequently riskier than those listed on major exchanges. They are more vulnerable to fraud, manipulation, and other risks, which can result in substantial losses for investors.
OTC stocks frequently have lower trading volumes, which makes it harder for potential investors to buy and sell their shares. This can result in decreased liquidity and increased transaction costs.
It has greater volatility: Although OTC stocks are frequently less well-researched and understood, they can experience more significant price swings and higher volatility. As a result, they can be riskier investments, especially for more conservative investors.
Should You Risk Short Selling OTC Stocks?
Short selling OTC stocks is allowed but comes with significant risks. These stocks often trade in low volumes, making them illiquid. If an investor needs to cover a losing short position, they may find it challenging to do so without incurring further losses.
OTC stocks are also prime targets for pump-and-dump schemes. Fraudsters use social media, emails, and other platforms to hype thinly traded stocks they own, driving up the price artificially. When the stock price peaks, they sell, leaving other investors with losses.
Because OTC stocks are less regulated and less known than exchange-traded stocks, they are often exploited in these schemes. Over-the-counter trading includes stocks, bonds, and derivatives, financial contracts tied to an underlying asset like a commodity.
OTC stocks are usually from smaller companies that don’t meet the listing criteria of major exchanges like the NYSE. These stocks, often priced under $5, tend to have weaker financial prospects and are generally speculative.
In contrast, successful companies like Microsoft, Meta, and Tesla started with stocks priced above $10 on major exchanges. These companies used their listed stocks to raise capital, fuel growth, create jobs, and boost the economy.
OTC market group
The OTC Markets Group, which is a publicly-traded company, handles the vast majority of OTC trades. OTC Markets classifies over-the-counter equities into three categories based on their size, share price, and amount of financial reporting and disclosure.
The highest tier is OTCQX® Best Market — companies with audited financials that can trade on regular exchanges. The next market is the OTCQB® Venture Market, which is for early-stage or growth companies with a minimum bid price of $0.01.
Pink Market
The Pink Open Market is the lowest tier and is considered a default market for broker aswell as dealers who want to trade OTC securities.This tier includes foreign companies, penny stocks, shell companies, and other businesses that choose not to share their financial information with the public.
Grey Market
The OTC Markets Group is only accessible to broker-dealers. The Grey Market, also known as Other OTC, is a catch-all category for any security traded over the counter but not quoted by broker-dealers due to a lack of investor interest, financial information, or regulatory compliance.
Beyond the major exchanges: An in-depth look at the types of investments traded over-the-counter (OTC)
Many OTC securities are stocks issued by small companies that do not meet the requirements for listing on major exchanges because they do not trade enough shares or their shares do not sell above a specific price. They are commonly called penny stocks because they trade for less than $5 per share.
Other OTC companies are more prominent, but they need to afford (or do not want to pay) the listing fees charged by the major exchanges. Companies can be charged up to $167,000 to be listed on NASDAQ.
Over-the-counter (OTC) trading occurs in over 10,000 securities. After their initial public offering, most bonds trade on the secondary market.OTC markets are considered better for bonds than stock exchanges due to the large size of trades, the number of bonds traded, and the infrequent trading of bonds.
Aside from stocks and bonds, OTC investments frequently include:
Derivatives:
Private contracts between two parties are typically arranged through the services of a broker. These can be options, forwards, futures, or other contracts whose value is determined by the intrinsic value of an asset such as a stock.
American Depositary Receipts ADRs
American Depositary Receipts, also known as ADSs, are bank certificates that represent a specific number of shares of a foreign stock.
Foreign currencies
Every day, more than $6.6 trillion in different currencies trade on the Forex, or over-the-counter currency exchange.
Cryptocurrencies
This includes bitcoin and Ethereum.
What happens if a stock goes to OTC
When a stock becomes over-the-counter (OTC), it is no longer traded on a major stock exchange, including the world’s largest, the New York Stock Exchange (NYSE)
If a stock no longer meets the listing requirements of a major exchange, it will typically trade over the counter.
Financial problems, such as bankruptcy or a company’s inability to meet minimum standards for market capitalization, share price, or trading volume, are all reasons for delisting.
When a stock goes OTC, its liquidity and visibility in the market may decrease, potentially making trading more difficult. Prices may also become more volatile as investors gain access to less information about the company and its financial performance.
In general, investing in OTC stocks is considered riskier than investing in stocks listed on major exchanges, and finding buyers or sellers for these securities may take more work. Before buying or selling OTC stocks, investors should exercise caution and conduct extensive research.
The perils of investing in OTC stocks: what every investor should know
OTC trading has a shady history. Part of this is due to the fundamental way it works. In contrast to the stock exchanges’ total transparency, where prices are available for the public. OTC is a buyer and seller secretly negotiating a price. The seller may offer the stock to one buyer at one price and another at another.
Unsurprisingly, OTC markets have been the site of scams and criminal activity. Dealing in penny stocks opens the door to illegal pump and dump schemes, in which someone promotes (pumps) a stock, then sells (dumps) the stock after you and other investors purchase it, causing the stock’s price to rise.
According to OTC Forex trader Frano Grgi, bonus scams are also a significant risk, citing the presence of unscrupulous “brokerages that want to lure beginners into trading by offering them large bonuses on their deposit.” Unfortunately, “when it comes time to withdraw funds, the money is gone,” Grgi says.
Regular investors can only buy (or sell) OTC stocks through a reputable broker-dealer via a powerful online platform such as OTC Markets. They function more like “discount” stock exchanges, imposing some rules and oversight and classifying stocks into tiers in the case of OTC Markets.
So before you invest, consider the tier you intend to use and the reputation of the broker-dealer who will handle your trades.
Conclusion
Investing in OTC stocks can offer unique opportunities, but it’s essential to weigh the risks alongside the rewards. Always conduct thorough research or consult a trusted financial advisor before diving into OTC stocks. This article provides valuable insights on investing in OTC stocks and the precautions to take. If you have any questions, feel free to share them in the comments below!
