Over-the-Counter (OTC) Stock Investing

An Over-the-Counter (OTC) stock is a security that is traded in an environment outside of the formal exchanges, such as the NYSE and the AMEX. Unlike the matchmaking service seen in these specialist exchanges, trading in the OTC market is made possible through a network of middlemen who carry securities in inventory facilitate the buy and sell orders of investors.

How OTC Stock Trading Works

In the United States, OTC trading in stocks is facilitated by market makers (firms that quote both a buy and a sell price on the stock with the hope of making a profit on the spread). Although the NASDAQ operates as a dealer network, NASDAQ stocks are generally not classified as OTC stocks because the NASDAQ is considered a stock exchange.

The Two OTC markets:

• Over-the-Counter Bulletin Board (OTCBB): An electronic community of market makers

• Pink Sheets: A daily publication offered by the National Quotation Bureau showing the bid and ask prices of OTC stocks

Companies that Trade Over-the-Counter

Generally, the reason a stock is traded over-the-counter is because the company is small and unable to meet the listing requirements of the exchanges. For this reason, the OTC market (while potentially presenting good investment opportunities for informed investors) has a high degree of risk. Many of these small companies are financially troubled and offer limited information regarding operations to potential investors. Very few OTC stocks successfully make the jump to any of the major exchanges due to their inability to meet their stringent listing requirements.

Further, many OTC stocks suffer from poor liquidity, which can lead to manipulation of the stock’s price. As a result, most brokers and large investment houses do not recommend or invest in OTC issues.

A Word of Caution to Investors

Most financial advisors suggest that investors should avoid the OTC market unless they can afford total loss of their initial investment. It is, however, worth noting that several strong several strong companies have chosen to switch to OTC trading in an effort to avoid the administrative overhead and fees that accompany listing on the major exchanges.

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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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