The process of purchasing or selling over-the-counter (OTC) stocks can be different from trading stocks that are listed on the New York Stock Exchange (NYSE) or the Nasdaq. This is because OTC stocks are, by definition, not listed.
- Over-the-counter stocks are known as penny stocks because most trade for under $1 per share.
- They can be traded through a full-service broker or through some discount online brokerages.
- Prices can be tracked through the Over-the-Counter Bulletin Board.
Purchases of OTC securities are made through market makers who carry an inventory of stocks and bonds that they make available directly to buyers. Some online brokers allow OTC trades. Full-service brokers offline also can place orders for a client.
What Are Over-the-Counter (OTC) Stocks?
Tens of thousands of small and micro-capitalization companies are traded over-the-counter around the world.
Over-the-counter stocks don't trade on a regulated exchange such as the NYSE or the NASDAQ. In most cases, they're trading OTC because they don't meet the stringent listing requirements of the major stock exchanges.
Many companies that trade over the counter are seen as having great potential because they are developing a new product or technology, or conducting promising research and development.
Others trading OTC were listed on an exchange for some years, only to be later delisted. A stock may be automatically delisted if its price falls below $1 per share. If the company is still solvent, those shares need to trade somewhere.
How OTC Stocks Are Different
OTC stocks are known as penny stocks because they generally trade for less than $1 per share. The companies that sell them usually have a market capitalization of $50 million or less.
Penny stocks have always had a loyal following among investors who like getting a large number of shares for a small amount of money. If the company turns out to be successful, the investor ends up making a bundle. If it doesn't, the loss is, hopefully, a small one.
Potential investors should be aware that these companies are not required to provide a lot of information about their finances, their business operations, or their products, as is required for companies listed on the regulated stock exchanges. It's important to take their statements with a grain of salt and do your own research.
How to Trade OTC Stocks
The first step an investor must make before trading OTC securities is to open an account with a brokerage firm.
If you're going with an online discount broker, check first to make sure it allows OTC trades. InteractiveBrokers, TradeStation, and Zacks Trade are among those that do.
The number of stocks trading on the over-the-counter market.
If you go with a real-world full-service brokerage, you can buy and sell OTC stocks. The broker will place the order with the market maker for the stock you want to buy or sell.
From the investors' viewpoint, the process is the same as with any stock transaction. As usual, they can place limit or stop orders in order to implement price limits.
Both stocks and bonds can be traded over the counter.
How OTC Stocks Are Different From Other Stocks
Most common stocks with real potential are priced over $15 per share and are listed on the NYSE or Nasdaq. Stocks priced below $1, which trade over-the-counter, may have murkier financial outlooks and are generally speculative and very risky.
Most successful stocks, such as Microsoft (MSFT), Facebook (FB), and Tesla (TSLA), all first listed their shares on the NYSE or Nasdaq with prices above $10.
Can Investors Short Sell OTC Stocks?
Although short selling is allowed on securities traded over-the-counter, it is not without potential problems.
These stocks generally trade in low volumes. That makes them Illiquid. An investor trying to cover an unprofitable short position could get stuck.
OTC securities also have been the focus of pump and dump schemes. Con artists use social media and email to heavily promote a thinly-traded stock in which they have an interest. This can create a high spike in the price of the stock. The con artists grab their profits and everyone else loses money.
These schemes often use OTC stocks because they are relatively unknown and unmonitored compared to exchange-traded stocks.