When you’re first starting out in the trading world, there’s a lot of nuances you should learn. One thing beginners fail to do is learn the different types of stocks. You see, there’s common stock, preferred stock, penny stocks, and stocks that trade over the counter – or on OTC markets. That said, before you even go out and buy a stock, you should learn the differences between these two stocks before you buy the wrong type of stock. That said, let’s take a look at the main types of stocks out there to get you jump-started on your road to trading success.
Types of Stocks
Let’s start with the most basic type of stock – common stock. Generally, when traders talk about stocks, they’re talking about common stock. So when you hear someone say, “I’m long Apple Inc. (AAPL) shares,” that means they bought shares of AAPL common stock. Basically, common stock is a type of security, or asset, that represents ownership of a corporation. Now, based on the capital structure of companies, common stockholders are at the bottom of the ownership structure. For example, if a company is filing for bankruptcy and wants to liquidate the common… well, common stockholders have claims on assets after bondholders, preferred stockholders, and other loaners. That means common stockholders will not be paid until all of the other creditors are paid in full.
That said, if you buy and hold common stock, it may be riskier than debt holders or preferred shareholders. Now, there is an upside to taking on this risk. Since common stockholders take on more risk than bondholders and preferred shareholders, they tend to outperform the latter. Now, there are thousands of common stocks that trade in the U.S. and they trade on public exchanges such as the New York Stock Exchange (NYSE), Nasdaq, NYSE Market, NYSE American, and NYSE Arca. Those that aren’t listed on these exchanges trade on the OTC markets, which we’ll explain later.
Now, in order for a company to issue common stock, the corporation must conduct an initial public offering (IPO). Companies will issue common stock in order to raise capital to expand operations. When conducting an IPO, the company goes through a stringent process. However, once the IPO is completed, anyone with a brokerage account is allowed to buy and sell the new common stock on the “secondary market”.
Moving on, let’s look at preferred stock.
Preferred stock is similar to common stock. They both trade on the secondary market. However, preferred stockholders have priority in the event of liquidation. Moreover, preferred shareholders have a higher claim on the company’s earnings and dividends than common stockholders. Now, unlike common stock, preferred stock doesn’t trade as much and they’re not as liquid. The reason being: preferred stock combines features of debt securities like bonds and they tend to pay fixed dividends, but still has the potential to rise in price.
Now, dividends on preferred stock can be paid at fixed intervals or they can be paid based on an interest rate benchmark. That said, preferred stock can be affected by fluctuations in interest rates, which may make it difficult for some traders to buy and sell. Not only that, preferred stock also takes into account the creditworthiness of a company. In other words, if the company has a bad credit rating, it would offer a higher interest rate because those stockholders are taking on a greater degree of risk. That in mind, many traders opt to trade common stock over preferred stock.
Let’s get to the fun part: penny stocks.
You’ve probably heard the term penny stocks before. However, you might think these are shady companies… well, they’re not. You see stocks have to start somewhere. For example, Monster Beverage (MNST) was once a penny stock:
Now, what do we mean by penny stocks here?
According to the U.S. Securities and Exchange Commission (SEC), penny stocks are securities issued by a small company that trades at less than $5 per share. That said, just because penny stocks trade under $5, it doesn’t mean they’re shady… it just means they’re cheap stocks and they allow you to potentially make money without spending a lot of capital.
For example, Jason Bond trades small cap stocks, as well as penny stocks. Here’s a look at one of his trades in which he used one of his three money-making patterns:
Well, here’s how the trade turned out, in profit and loss (PnL) terms:
You see, not all penny stocks are shady. Blue Apron (APRN) is a company that many consumers use. That said, next time you hear the term “penny stocks“, don’t get scared by them… conduct your due diligence and learn about the company, the chart patterns, value, and any potential catalysts.
Moving on, there are OTC markets stocks.
OTC Markets Stocks
There is typically a negative connotation when it comes to OTC markets stocks. Many people will tell you to avoid stocks listed on OTC markets at all costs. However, that’s simply bad advice because you’re limiting your ability to learn about different types of stocks, which would ultimately limit your knowledge about the market. In turn, you may miss out on opportunities. For example, Jeff Williams trades penny stocks – some of them are listed on the OTC markets – and he was able to do this with his account:
That said, it pays to learn about OTC markets stocks. Now, let’s take a look at OTC markets.
There are three tiers to the OTC Markets – this market hosts thousands of U.S. and global securities. The three tiers are The OTCQX Best Market, The OTCQB Venture Market, and The Pink Open Market.
OTCQX Best Market
This is considered the highest tier on the OTC markets. Companies listed in this tier must meet a high level of financial requirements, accounting and reporting standards. Additionally, they must be in compliance with U.S. securities laws, and have a third party sponsor introduction. That said, there are a plethora of companies are in this tier, and they collectively have a market cap of over $1 trillion. You’ll find companies like Adidas and Overstock.com Inc. Class B preferred stock trade here.
The next tier is the OTCQB.
OTCQB Venture Market
Now, the requirements for listing on OTCQB Venture Market are not as stringent as the OTCQX Best Market. However, there are still certain thresholds and requirements that need to be met. For example, companies must report to a U.S. regulator or must be listed on a qualified international stock exchange. Not only that, OTCQB Venture Market companies must conduct an annual management certification process in order to verify officers, directors, controlling shareholders, and shares outstanding. Additionally, the minimum tick size is 1 penny – this requirement is used as a way to cut down on potential penny stock schemes. That in mind, you can find companies like Fannie Mae and Freddie Mac, which are government-sponsored enterprises, on OTCQB Venture Market.
Pink Open Market
This is the third tier in OTC Markets. This part of OTC markets is often considered the most challenging for investors and penny stock traders. The reason this tier is so difficult to trade: there is no minimum financial standards, and it consists of companies that might not provide enough information about its operations. Consequently, this makes it difficult for traders to conduct their due diligence.
Now, the Pink Open Market is further broken down into three segments: Current Information, Limited Information, and No Information. Additionally, there are two more market designations: Caveat Emptor and OTC, Other OTC or Grey Market.
If you don’t know the lay of the land and start trading third-tier OTC markets stocks… you could potentially lose a significant portion of your capital. In this tier, you’ll find stocks trading sub-penny and some of the penny stock schemes occur. In order to prevent traders and investors from being caught in penny stock schemes, OTC Markets does its best inform market participants about stocks.
When you go to the webpage of an OTC Pink stock, you’ll see warning signs like this:
If you want to be successful in trading penny stocks – specifically those listed on OTC markets – well it helps when you have a mentor.
Final Thoughts on Types of Stocks
Well, you should have a good idea of the types of stocks out there and the differences between them. You’ve got common stock, preferred stock, penny stocks, and stocks listed on OTC markets. For the most part, successful traders focus on common stock, penny stocks, and OTC markets stocks. Before you even go out and start trading stocks… learn about the trading process and the intricacies of the market. Once you’ve got things figured out… if you have the right strategy and understand the stock market, well… the possibilities are endless.