Not every company can be found on the major indexes, which include the Dow Jones Industrial Average (DJIA), Nasdaq Composite Index and the S&P 500. Many companies that offer exceptional value are still starting out and can be found on the Over the Counter (OTC) market.
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 one another through computer networks or over the phone.
These stocks are still normally governed by the Financial Industry Regulatory Authority (FINRA).
OTCs at a glance
The OTC network, which isn’t limited to stocks, 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/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. If you don’t have a broker and want to start trading, check out Benzinga’s 2018 Best Online Brokerages.
You can compare some of our favorites below..
| Broker | Best For | Commissions | Account Minimum | Choose your platform |
|---|---|---|---|---|
Ally Investment
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$0 | $0 |
Get started
securely through Ally Investment's website
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1 Minute ReviewIf investors are on the hunt for a bargain broker, Ally Invest could be the one. With low commissions across the board, Ally Invest (formerly TradeKing) stops potential investors in their tracks with its especially low mutual fund commissions. Commissions on stocks and ETFs are notoriously inexpensive as well, and for more active traders or those with larger account balances, commissions can dip as low as $3.95 per trade. Pros
Cons
Current Promotion$3.95 per stock trade for Active Traders at Ally Invest |
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TD Ameritrade
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$0 $6.95 for OTC Stocks | $0 |
Get started
securely through TD Ameritrade's website
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1 Minute ReviewThis publicly listed discount broker, which is in existence for over four decades, is service-intensive, offering intuitive and powerful investment tools. Especially, with equity investing, a flat fee is charged, with the firm claiming that it charges no trade minimum, no data fees, and no platform fees. Though it is pricier than many other discount brokers, what tilts the scales in its favor is its well-rounded service offerings and the quality and value it offers its clients. Pros
Cons
Current PromotionTrade commission–free for 90 days & get up to $2500 |
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eTrade
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$0 | $0 |
Get started
securely through eTrade's website
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1 Minute ReviewE-Trade is best known for its user-friendly browser, desktop and mobile trading platforms and its extensive research and educational information. E-Trade may not have the lowest commissions compared to discount online brokers, but customers certainly get their money’s worth from E-Trade’s comprehensive offerings. Pros
Cons
Current Promotion60 days of commission-free trades with deposit of $10,000 or more |
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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
Final thoughts
You shouldn’t make OTC stocks a core component of your portfolio. Investments in OTC companies should be treated as highly speculative. Understand that these companies are listed on the OTC and not the major exchanges for a reason. This can range from bad credit to not meeting the required accounting standards.
Keep in mind that the way in which orders are fulfilled on the OTC exchanges differ from regular markets. Make sure you visit FINRA’s website and research what occurs with these orders so you can fully prepare for what to expect when trading on the OTC markets.
