Over-the-counter (OTC) stocks are stocks commonly offered by smaller companies on informal stock exchanges. OTC stocks are often much cheaper than other stock varieties and are sometimes overlooked by investors as a result. However, this stock option can be a great investment and complementary to an investor’s portfolio. Here we look at what over-the-counter stocks are, the three different OTC marketplaces, and the pros and cons of purchasing OTC stocks to help you get started.
What Is an Over-the-Counter Stock?
Over-the-counter stocks are those that are not listed on formal stock exchanges but are rather traded over-the-counter through a broker-dealer network. A broker-dealer network is a network that relies on a firm or person to complete all of the stock tradings on behalf of its customers. Companies that use OTC stocks often do so because they can’t meet the listing requirements needed to sell their shares on formal stock exchange markets like Nasdaq and the New York Stock Exchange (NYSE).
OTC stocks are typically very inexpensive and typically cost $5 or less per share. Stocks that are less than $5 are referred to as penny stocks.
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There are three primary OTC marketplaces where traders and investors purchase OTC stocks. These marketplaces include:
- OTC Pink: This is the least-regulated OTC market and is popular among smaller companies that aren’t able to meet the stringent requirements of traditional exchange markets and other OTC marketplaces. It is also known as the Pink Open Market.
- OTCQB: This marketplace is a step up from the OTC Pink marketplace and requires minimal standards to be able to list shares. The primary requirement is the ability to meet a $0.01 price test. The OTCQB market is also referred to as the Venture Market.
- OTCQX: This is the highest-regulated OTC marketplace and is used by multinational corporations and companies that want to offer blue-chip stocks, or stocks that have a market valuation of at least $10 billion. The OTCQX market is also known as the Best Market.
The Benefits and Challenges of the OTC Marketplace
Investing in OTC stocks and trading within the OTC marketplace comes with both benefits and disadvantages.
The benefits of the OTC marketplace include:
- Access to securities not available on traditional stock exchange markets.
- Fewer regulations that enable more companies to list their shares.
- The ability to trade penny stocks and other low-cost stock varieties to earn significant returns.
The disadvantages of using the OTC marketplace include:
- Fewer regulation requirements that make it more difficult to find information on a company before purchasing that company’s stock.
- Increased volatility, so a trader must have a high appetite for risk when investing.
- Lower trade liquidity as a result of low volume, which can result in delays in the completion of a trade.
OTC stocks are a great option to consider when looking for new investment opportunities. Understanding these types of stocks and how the OTC market works can guide you when deciding if this type of investment is right for you.