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Many companies that offer exceptional value are still starting out and can be found on the over the counter (OTC) market.
Buying or selling stocks OTC is different than trading stock on the New York Stock Exchange or the NASDAQ. Learn more about the OTC market and how you can starting trading with our review.
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What are OTC Stocks?
OTC stocks are generally too small to meet the requirements needed to list on the major exchanges. These stocks are traded by broker-dealers that negotiate directly between 1 another through computer networks or over the phone.
These stocks are normally still governed by the Financial Industry Regulatory Authority (FINRA).
OTCs at a Glance
The OTC network isn’t limited to stocks. It encompasses any financial instruments that aren’t directly traded through a central exchange, including stocks, bonds and derivatives.
Some major differences between the OTC exchange and major exchanges include:
- Transaction transparency, which means you may be limited on what bids and offers you can see based on your broker, rather than seeing all orders available, including markups on foreign exchange stocks.
- On major exchanges, every party receives offers from every counterparty. This doesn’t always occur on the dealer exchange and can create information disparity.
- OTC exchanges have fewer rules and regulations than centralized exchanges. This leads to higher competition between the providers to get more volume for their firms, which results in lower transaction costs.
- Stocks found on the OTC market are often penny stocks with prices as low as $0.05 to $0.10. Coupled with large spreads, you can end up buying a stock at the $0.10 ask price, and it can immediately trade to the $0.05 bid price and lose 50% of its value.
Pros and Cons of OTC Stocks
OTC stocks have some distinct advantages and disadvantages to the centralized exchange-traded stocks:
Pros of OTC stocks
- OTC stocks allow you to trade companies that not only don’t list on major exchanges but also shares of companies in foreign markets.
- Transaction costs can be much lower on the OTC networks.
- Given the smaller size of companies, your investments will give you a much larger stake in a company.
Cons of OTC stocks
- The lack of liquidity can leave you with stocks that are hard if not impossible to sell.
- Companies listed on the OTC exchange may provide less accounting information than the regular exchanges.
- Stocks that generally trade on the OTC do so because they have bad credit, don’t make much money or are just starting out, which makes them fairly risky
How to Purchase OTC Stocks
If you’re interested in purchasing shares of a company that trades on the OTC market, follow these steps:
1. Determine how much you want to invest
OTC stocks are inherently riskier than those traded over the regular exchanges. Treat these stocks as speculative and size your positions appropriately. Don’t invest money you’re not willing to lose.
2. Find an appropriate broker
Many of the major brokerage firms that you use for regular stock trading allow for the trading of OTC stocks. Fees can vary for OTC versus regular stocks, so make sure you understand what the costs are relative to normal trading.
Take a look at our recommended brokers to get started.
3. Fund your account
Many of the major brokerages allow you to trade the OTC market. You’ll need to check whether you would be eligible to trade on OTC markets with your broker.
4. Purchase your OTC stock
While it’s fairly easy to purchase stocks on the major exchanges, it may take a bit more to understand how to execute a trade on the OTC markets. Consult customer service for your broker-dealer to understand how to execute an OTC trade through its specific platform.
When you place an order, you’ll have an option for market orders or limit orders. With a lower liquidity, the spreads can be much wider than on normal exchanges.
Your broker-dealer has a few options when handling your order. It’s possible to fill the order internally by matching clients within the brokerage. Otherwise, brokers can send the quote out to the OTC market to make the trade with another broker-dealer.
If an order is not marketable, the broker-dealer may need to change the existing quote to reflect the new price or size
Get Started in OTC
Investments in OTC companies should be treated as highly speculative. Don’t make OTC stocks a core component of your portfolio.
Be sure to visit the FINRA website to research and prepare for what to expect trading on the OTC markets.
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