OTC Stock Trading

By Stock Research Pro • March 26th, 2011

OTC stock trading (over-the-counter) refers to buying and selling stocks outside of the formal exchange environments (e.g. NYSE, AMEX). OTC stocks are usually issued by smaller companies that are not able to meet the listing requirements of the exchanges and are instead traded through the coordination of market makers and brokers. Although Nasdaq works through a dealer network, the Nasdaq is considered to be a stock exchange and so its stocks are generally not considered OTC stocks.

How the OTC Market Works

OTC stock trading is facilitated through direct negotiations between market makers (the company that holds the stock in inventory and quotes both the buy and sell price) and the brokers. The two main OTC markets in the United States are the Over-the-Counter Bulletin Board (OTCBB) and Pink Sheets. The OTCBB primarily focuses on former Nasdaq stocks while Pink Sheets trades very small companies (usually with 300 shareholders or fewer). When an investor looks to trade an OTC stock, they need to open an account with a broker who will then relay the order to a market maker for that stock.

Differences between OTCBB and Pink Sheets

The primary difference between the OTCBB market and Pink Sheets market is the regulation and administration of OTCBB by FINRA (Financial Industry Regulatory Authority). Pink Sheets, in contrast, operates as an independent marketplace. Companies that are quoted on the OTCBB adhere to a through two-year auditing process. OTCBB companies are not, however, regulated by market capitalization (“market cap”), share price minimums, or corporate governance.

The Risks of OTC Stock Trading

Trading in OTC stocks carries two major risks:

  • Lack of company information- The risk that is most commonly associated with trading in OTC stocks is the lack of information available on the issues. Unlike the larger and more reputable companies that list on the major exchanges, OTC stocks often will not make financial reports (e.g. quarterly or annual statements) available for review by the public.
  • Misleading pricing- While the major exchanges make readily available the price and volume information for the stocks they list, that data is not easily accessed for many OTC stocks. Often, the OTC broker will build their commission right into the price of the stock, leading to confusion regarding the real value.
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    The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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