You may be familiar with major stock exchanges like NASDAQ and the New York Stock Exchange. What you may not realize is that there’s a whole other world of stock trading called over-the-counter stocks. Get to know what this alternative type of trading entails in this quick guide.
What Are Over-the-Counter Stocks?
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Over-the-counter (OTC) stocks are traded on one of the three OTC markets. In order to buy or sell an OTC stock, you need to work with a market maker or broker-dealer. Since OTC stocks aren’t listed on the national securities exchanges, they are called unlisted stocks.
Many companies sell their shares on the OTC market because there are fewer requirements they must fulfill. Small companies benefit from this option since selling on the major exchanges requires a lot of capital and manpower. With the OTC markets, they can gain capital without having to jump through as many hoops to get there.
The Three Major OTC Marketplaces
Companies can sell OTC stocks on three different marketplaces. Each of these markets has varying levels of restrictions. Keep in mind that the lower the tier, the more risk you are accepting. Get to know a little about each one:
- The OTCQX® Best Market: This is the top tier of the OTC market. It has the most requirements, like financial standards, accounting and reporting standards, compliance with U.S. securities laws, and third-party sponsor introduction. Within this tier are around 400 companies that have a market cap of over $1 trillion.
- The OTCQB® Venture Market: This is the second tier of the OTC market. It is less restrictive than the top tier; however, companies still need to meet a certain set of standards. Companies need to either be listed on a qualified international stock exchange or report to a U.S. regulator. They also need to complete an annual management certification process.
- The Pink® Open Market: This is the third and most lenient tier of the OTC market. There are no minimum financial standards to enter this market. It’s a risky place to trade since many companies are reluctant to provide sufficient information.
The Advantages and Challenges of Trading in OTC Markets
A major advantage of trading in the OTC markets is that you can invest in up-and-coming companies. For instance, many of the stocks here are considered penny stocks. That’s because they are worth less than $5 per share. If you were to invest in these and get lucky, you could make a serious profit.
One drawback of the OTC markets is that they can be extremely risky. It’s difficult to find sufficient information about many of the companies in the Pink® Open Market. Without this information, it’s challenging to make smart trades. Likewise, many of these stocks are very volatile, so you can’t anticipate where they will go.
Investing in OTC stocks is one of many ways you can enhance your portfolio. When getting into this alternative type of trading, keep in mind that the risks can be high.