What Are OTC Stocks (Over the Counter) & Are They Safe?
What are OTC stocks? It stands for (over the counter). They are also known as “pink sheets”. These are the type of stocks commonly referred to as “penny stocks”, and are alluring to novice traders. They offer you the opportunity to turn a small investment into a potential fortune if the company turns out to be highly successful. However, they aren’t without their risks. They are not as regulated as the penny stocks on major exchanges. If you’re curious to know more about these elusive stocks, you will want to watch this video.
OTC Stocks Explained:
Many new traders want to know what are OTC stocks before they decide to trade them. The main thing to know is that OTC stocks are not sold on the major stock exchanges. The reason they are not listed on these exchanges is because don’t meet the qualifications. They simply are not “good enough” to make the standards. That being said, they’re prone to pumping and dumping, lack of volume, and occasional spikes of volatility up…or down. Because they behave this way, you NEED to know how to trade them safely.
If you’d like to trade pennystocks that are traded on the major exchanges than check out our penny stocks list, where we vet each ticker for the proper technical setup the night before the bell rings.
A Centralized Exchange: The Typical Way to Purchase Stocks
Most of us assume when we buy a stock is from a centralized/formal exchange like the NYSE (New York Stock Exchange) or the TSX (Toronto Stock Exchange). And, for the most part, you’re right.
Stocks that trade on the exchanges named above are called listed stocks. On the contrary, stocks that trade via OTC are called unlisted stocks.
A centralized market has all its orders routed through one central exchange with no other competing market.
In this type of set up, the quoted price is the only price available to any trader looking to buy or sell. Now the benefits of this set up might not be immediately apparent, but they are vast.
In simple terms, a centralized market is good because it keeps trades fair. Furthermore, the price action tends to be more predictable because there is no competing price model for the individual stock.
Not only are they fair, but they are also highly regulated. Most of these centralized exchanges have licenses and runs under government regulations. This is a more “safe space” for traders to trade in.
All things considered, this gives the trader peace of mind if something goes wrong. To this end, trading on a centralized exchange is the preferred choice for many.
A Decentralized Exchange: A Less Common Way to Buy Stocks
Penny stock charts are made up of candlesticks. Each candlestick tells a story as well as form support and resistance. Bullish candlesticks and bearish candlesticks are easy to understand. Price is going up or going down.
What about doji candlesticks? Those show indecision. There’s also different kinds of doji candles that can give you different information. If you saw a doji forming on the daily chart of a penny stock, how would you trade it?
The real bodies and wicks of candlesticks form key levels of support and resistance. Support and resistance is another foundational aspect of trading.
They are levels every single trader pays attention to. If someone is telling you it doesn’t matter in penny stocks, you should take a good hard look as to why they’re saying that.
Does Technical Analysis Work With Penny Stocks?
Now I know what you are thinking…we aren’t talking about bitcoin or block-chain when we refer to a decentralized exchange. As mentioned earlier, OTC securities do not meet the requirements for listing on a standard market exchange like the NYSE.
So instead of trading on the centralized exchange, OTC stocks are traded through a broker-dealer network. Over-the-counter (OTC) is the name used for the process of how stocks are traded for companies not listed on a formal exchange. The broker-dealer acts as order matchmaking service to facilitate the buy or sell orders.
The Over the Counter Bulletin Board (OTCBB)
OTC stock trades take place through the Over the Counter Bulletin Board (OTCBB). The OTCBB is an electronic quotation and trading service that facilitates higher liquidity and better information sharing.
Moreover, broker-dealers negotiate directly with one another over computer networks and by phone.
Examples of OTC Securities Traded Through the Dealer Network
- American Depository Receipts
Are OTC Stocks Safe?
As we’re learning the answer to what are OTC stocks, we have to ask if they’re safe? Typically they’re high risk micro stocks. And they’re high risk because they’re not subject to regulations. In other words, they’re like the wild west of trading. Doesn’t mean you can’t trade OTC stocks, however. You just need to be precise in how you trade them. Check out our penny stock trading strategies course.
Characteristics of OTC Stocks And What To Look For
Stocks that trade OTC are typically smaller and developing companies that cannot meet exchange listing requirements of formal exchanges.
Depending on the platform they’re listed with, they may also submit reports to the Securities and Exchange Commission (SEC) regulators.
OTCBB stocks will usually have a suffix of “OB” and must file financial statements with the SEC. We may not put OTC stocks on our watch list, but we do have penny stocks on there.
The Risks of OTC Stocks
Any major exchange requires full transparency, up to and including all financial dealings. For the most part, the stock must remain over $1.00 per share.
Those companies not willing to play by the rules – perhaps they’re in bankruptcy filings, will often trade on the OTC market. For these reasons, it comes as no surprise they are easily subjected to corruption.
Another downside of OTC stocks is their lack of liquidity, which makes them far more susceptible to manipulation. Henceforth they can be dangerous to trade.
Not to mention, they aren’t listed on centralized exchanges and don’t have to follow strict rules and regulations.
One Compelling Reason Why Companies List on Decentralized Exchanges
Some companies go the OTC route because they can’t afford the steep price tag to list on the NYSE – $500,000 to be exact.
The Nasdaq is a tad bit more digestible at $75,000. But, at the end of the day, the entry fees are a barrier to entry. Furthermore, these exchanges have strict entry criteria that some companies can’t or don’t want to meet.
However, some large and reputable companies choose to trade on the OTC market. Take, for example, the well-known companies Nestle SA, Bayer A.G., and Danone SA. All of these companies trade on the OTCQZ platform.
What Are Some of the OTC Markets?
- Best Market (OTCQX)
- Venture Market (OTCQB)
- Pink Open Market
In case you didn’t know, the OTC Markets Groups owns and operates all three. In fact, they are the largest U.S. inter-dealer electronic quotation and trading system for over 10,000 OTC securities.
Although these securities aren’t listed on formal exchanges, they do have requirements. For example, the OTCQX; it doesn’t list stocks under five dollars, shell companies, or companies going through bankruptcy.
By the same token, we typically see shares of large market cap companies on the OTCQX Best Market.
Are OTC Stocks Hard to Sell?
You’ve heard of bag holding right? That typically occurs because of a problem with liquidity. As a result, that makes OTC stocks hard to sell. The bid ask becomes so spread out that you can’t find buyers to fill your sell orders. Then you’re left hold the bag and hoping and waiting for volume and liquidity to come back in.
The Pink Sheets
Another trading platform is the Pink Sheets. These stocks will usually have a suffix of “PK” and don’t have to file financial statements with the SEC.
Typically, stocks wind up on here due to their failure to meet the SEC requirements for listing on larger stock exchanges (i.e. the lack of financial information or their stock price falling below one dollar).
While buying shares of this nature may involve lesser transaction costs, they are prime for price manipulation and fraud.
Unfortunately for investors, but perhaps fortunately for company owners, pink sheet listed companies are private and have next to no oversight or regulation.
If you want to know their detailed financial information and business data, you’re out of luck. Investors are in the dark, and this is where the risk comes in. As a rule, we like to check Stock Rover first before making any investments in a stock. If the fundamental data looks poor, we look elsewhere.
Pros of the OTC Market
- You have access to securities not available on standard exchanges such as bonds, ADRs, and derivatives.
- Less regulation allows many companies who can not, or choose not to, list on other exchanges the ability to trade stock.
- You have the potential for significant returns on low-cost, penny stocks. Especially during news catalysts. Retail traders trade them which can make them very volatile.
Risks of the OTC Market
- Low liquidity and inability to sell shares at a desirable price.
- Less regulation and a higher possibility of fraud with pink sheet listed stocks.
- OTC stocks are volatile and vulnerable to rapid moves with the release of the market and economic data.
- Huge bid-ask spreads make it harder to trade profitably due to slippage.
Good to Know Facts
- The over-the-counter (OTC) market is a decentralized market where securities, not listed on major exchanges, are traded directly by a network of dealers.
- Dealer networks are utilized for trading securities over-the-counter as opposed to a centralized exchange.
- You can trade OTC stocks through a full-service broker or with some select discount online brokerages. We recommend TradeStation.
- Some companies raise capital through the sale of OTC stocks.
- Although Nasdaq operates as a dealer network, Nasdaq stocks are generally not classified as OTC because the Nasdaq is considered a stock exchange.
- Pink sheet stocks are usually small penny stocks, which are stocks that trade for less than five dollars per share.
In my opinion, the most important lesson that you can learn from reading this blog is that you need to be careful in choosing the stocks you trade.
If you’re serious about learning how the stock market works, you need to put in time and effort. By practicing diligently and honing your technique–making money from day trading is within grasp. Here at the Bullish Bears we prefer trading stocks off our stocks list, but that won’t stop us from trading an OTC now and again. Of course everything we do must be under the right conditions to place a trade.
Profits can and will come with practice, the right tools, software, and proper ongoing education.
Now is as good a time as ever to get started. Let us show you how to choose the right stocks and how to protect yourself from worthless companies with our trading courses.