Most probably, many have heard about IPOs, when a large company enters the exchange, and many investors try to buy the stocks at such a moment. However, this is not the earliest stage of investing in a company. Before entering the exchange, the stocks can already be bought and sold; here emerges the OTC, or over-the-counter, market, which has a certain difference with the traditional stock market. In this article, we will discuss this market and the possibility of making there more money than on the exchange.
What is the OTC market?
OTC (Over-the-counter) trades include buying securities that are not registered officially on an exchange, such as the New York Stock Exchange (NYSE). Such stocks do not comply with the rules of placement on a standard exchange.
Trading is carried out via an OTCBB (Over-the-Counter Bulletin Board) or the listing service Pink Sheets. The OTCBB is an electronic service of quotations and trades that enhances liquidity and information exchange. In its turn, the Pink Sheets is a private company that works with broker-dealers to prepare the stocks of small companies for the IPO.
What are OTC stocks?
The main difference here is that such securities are not traded on a regular exchange. As a rule, they cost less than 1 USD per stock, also being called Penny Stocks, and the market capitalization of the company is below 50 million USD.
Such a low cost of the papers allows a private investor to buy a lot of stocks at a low price. And if the company manages to make a high-quality product and become successful, the investor may increase their initial investment many times.
A serious risk here is the lack of useful information about the company, which prevents us from evaluating its potential for growth. That is why the investor has to evaluate the securities and calculate the risks themselves.
Main types of OTC
Every day, more and more stocks appear on the OTC market. Trades are carried out automatically, via the telecom system. A serious drawback here is the possibility of manipulations with this market and several fraud schemes. There is an opinion that SEC, the regulating organization on securities and exchanges, has a negative attitude towards this market. For the investor to evaluate the transparency of the company and the potential of growth easier, there is a system of categories that helps assess the risks
- Best Market (OTCQX) is the most prestige category. Here, the stock price is never below 5 USD. A price below this threshold is thought to possibly reveal a fraud company or a one on the verge of bankruptcy.
- Venture Market (OTCQB) — to comply with this category, the company has to give a full account of its finance to SEC. If the requirements of the regulator are fulfilled, it remains in the category, but as soon as it breaks them, it is transferred to the Pink Open Market.
- Pink Open Market features a whole range of companies that do not comply with the requirements of SEC. Their stocks can be bought very cheaply, but the risk of fraud is high.
The peculiarities of trading OTC stocks
OTC trading is an alternative for small companies. The process of entering a regulated exchange may be laborious and complicated for the company, while placement on the OTC allows attracting capital quickly. The requirements of OTC platforms differ significantly, and sometimes it is hard for the investor to find financial information about the company. The volume of trading is lower here but the stocks are traded much cheaper than they really cost, and you can make money on this.
It should be remembered that OTC stocks have less liquidity due to the low demand for them. So, here trading may be happening with lags, and the difference between the buying and selling price may change significantly due to the market situation. There are high probabilities of fraud because the company does not provide financial accounts. On the other hand, there might be maximally volatile movements at the moments of publication of certain economic data.
Most regulated securities with a good potential of growth and ok financial accounts cost over 15 USD per stock. As a rule, such stocks are traded on NYSE or NASDAQ. OTC stocks are traded below 1 USD per stock, most of the financial accounts of such companies are unavailable, and buying such assets is always risky.
However, having just a small sum on your deposit, you may risk and invest. Not every private investor can buy 100 Apple stocks at 275 USD per stock but they can afford 1000 OTC stocks costing 0.1 USD, which, in the end, may bring an even larger revenue than pricy stocks of the leading companies.