When it comes to over-the-counter (OTC) stocks, there is a ton of misinformation. Some people will tell you to avoid them altogether, but that’s simply bad advice when you realize the pros and cons of trading them. In fact, as an active trader, you should always be on the hunt for potential opportunities regardless of what forum they trade on.
What Are OTC Stocks?
OTC (over-the-counter) stocks are a way for small companies to sell stocks outside of the traditional larger stock exchanges like the NYSE and Nasdaq. The sales are handled directly through brokers and dealers.
How Do OTC Markets Work?
Because companies that trade stocks in OTC markets do not have to meet the requirements to trade on the larger markets, they carry some inherent risk. Traders should do research on the companies and the OTC markets where they are listed.
How to Trade On OTC Markets
There are three tiers to the OTC Markets which is the home to nearly 10,000 U.S. and global securities and nearly a $1 billion worth of volume. Now, in comparison to exchanges like the NYSE, and NASDAQ, OTC stocks trade through market makers, whose job is to match and facilitate orders. The three tiers are: The OTCQX® Best Market , The OTCQB® Venture Market , and The Pink® Open Market.
The OTCQX® Best Market
Now, this is the highest tier on the OTC. Companies must meet a high level of financial requirements, accounting and reporting standards, be in compliance with U.S. securities laws, and have a third party sponsor introduction. There are roughly more than 400 companies that fit in this tier, and they have a market cap of of over $1 trillion. You’ll find companies like Adidas and Danone trade here.
The OTCQB® Venture Market
This is the second tier on the OTC. Although the requirements are not as stringent as The OTCQX® Best Market, there are certain thresholds that need to be met. For example, companies must report to a U.S. regulator or be listed on a qualified international stock exchange. In addition, companies must conduct an annual management certification process to verify officers, directors, controlling shareholders, and shares outstanding. Not only that, but the minimum tick size is 1 penny, used as a way to cut down on potential stock schemes. Here you can find companies like Fannie Mae and Freddie Mac trade.
The Pink® Open Market
The third tier in the OTC Markets, and the most challenging for investors and traders, is the Pink® Open Market . The reason being, there is no minimum financial standards, and it consists of companies reluctant to provide sufficient enough information for investors to make thoughtful decisions. With that said, this tier is broken down even more into three segments: Current Information, Limited Information, and No Information. And the plot thickens by having two more market designations: Caveat Emptor and OTC, Other OTC or Grey Market.
Generally speaking, investors need to be careful with some of these companies because of the lack of information they’re willing to disclose. In this tier, you’ll find stocks trading sub-penny and some of the penny stock schemes occur. However, OTC Markets does its best to inform investors.
You’ll see signs like this one:
As you can see there are levels to the OTC Markets. As investors and traders, it’s our job to find money-making opportunities in the market. Of course, not all OTC stocks are the same and it’s up to us to do due diligence before making any investment and/or trading decisions.