Over-the-counter stocks, also known as OTC stocks, are stocks that trade outside of the major exchanges. This means that they aren’t traded on an exchange like the New York Stock Exchange or NASDAQ. Instead, they are traded through a network of dealers. OTC stocks are typically issued by smaller companies and may be more volatile than stocks that trade on major exchanges.
Let’s have a look at what OTC stocks are and how they differ from stocks that trade on major exchanges.
What are OTC stocks and why are they volatile?
OTC stocks are typically small-cap stocks, meaning they have a market capitalization of less than $2 billion. They tend to be more volatile and easier to manipulate than larger stocks, which is why they’re often overlooked by institutional investors.
OTC stocks may be more volatile than exchange-listed stocks because they often have less liquidity and less disclosures requirements. For example, a company that is listed on a major exchange is required to disclose its financials to the public on a regular basis. A company that is not listed on a major exchange may not have the same disclosure requirements. OTC stocks may also be penny stocks, which are defined as any stock that trades for less than $5 per share.
For individual investors, OTC stocks can offer an opportunity to buy into a company before it lists on a major exchange (known as going public). If the company goes on to succeed, investors can enjoy significant returns.
While there’s no guarantee that every OTC stock will be a winner, doing your research and investing in companies with solid fundamentals can help you avoid some of the risks associated with these types of stocks.
How do OTC stocks work
Over-the-counter (OTC) stocks are not listed on a major exchange and are traded through broker-dealers that communicate with one another over electronic networks.
In order to trade OTC stocks, investors must first open an account with a broker that offers OTC trading. Once an account is established, investors can place orders for OTC stocks through their broker. When an investor wants to buy shares of an OTC stock, their broker will find another broker who is willing to sell the shares. The two brokers will then agree on a price and the trade is executed.
Most trades of OTC stocks are settled in two business days.
The benefits of trading OTC stocks
- OTC stocks are generally easier and less expensive to trade than exchange-listed stocks. For example, there is no need to pay exchange fees or meet certain listing requirements.
- As previously said, OTC stocks tend to be more volatile than exchange-listed stocks, providing an opportunity for greater profits (or losses). For these reasons, many traders prefer to trade OTC stocks.
The risks of trading OTC stocks
- One of the biggest risks is the lack of liquidity. Because OTC stocks are not traded on a major exchange, there may be only a limited number of buyers and sellers. This can make it difficult to sell your shares, especially if you need to do so quickly.
- Also, OTC stocks may be less regulatory oversight than exchange-listed stocks. This can make it easier for fraudsters to manipulate prices or engage in other deceptive practices.
The best ways to research OTC stocks
The best way to research a stock will vary depending on the type of stock and the level of risk you are comfortable with. For example, if you are interested in buying penny stocks, you may be comfortable with a higher level of risk.
However, if you are investing in a blue chip stock, you may want to focus on analyzing the company’s financial statements and looking for red flags.
No matter what type of stock you are interested in, it is important to develop a solid research strategy that fits your individual needs.
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Disclaimer: these articles are for educational purposes only. Market analysis, prices, news, trade ideas, or any other information within this site or the chatroom is not investment advice.