Stake Academy Wall St: OTC Stocks
Over-The-Counter (OTC) stocks aren’t the type that you’ll find on a typical exchange, so what are they and how can you use them in your portfolio?
OTC Stocks are commonly confused with being just Pink Sheet companies. But actually there are a variety of OTC stocks, and these non-exchange-listed stocks include multi-billion dollar global companies like Adidas ($ADDYY) and Nintendo ($NTDOY).
So let’s dive in and find out more on how these OTC stocks work and how to get access.
Two major questions arise surrounding OTC stocks.
Without an exchange, how do these shares change hands? Such shares are traded through broker-dealer networks. Using an electronic system, scores of broker-dealers are posting stocks on offer. Trades are executed directly between the buyer and seller without the need for a third party exchange to settle transactions.
A company called the OTC Markets Group runs these networks through three major marketplaces:
Best Market (OTCQX): Best Market has the most stringent report requirements and is the home to multi-billion dollar foreign companies. The majority of OTC stocks available on Stake fall into the OTCQX category, although only 4% of OTC stocks are in this tier. Stocks under US$5 in price are also ineligible for OTCQX trading.
Venture Market (OTCQB): The middle tier, with companies that tend to be early-stage or developing.
Pink Sheets: Such companies don’t have to report to the U.S. Securities and Exchange Commission (SEC). While pink sheets may have a bad image, some big names like Nintendo fit into the category. U.S. regulators may not monitor such stocks, but foreign regulators may.
Why would a company go OTC rather than on an exchange? In short, listing on an exchange is difficult and costly. For companies of a certain size, the costs accrued to both list and comply with the yearly SEC and Financial Industry Regulatory Authority (FINRA) audits keep them out of the major exchanges.
For bigger companies, like the OTC stocks found on Stake, they are generally foreign American depositary receipts (ADRs). These companies are already listed on a local market and an OTC listing provides an easier option for foreign investors to access the stock. Another reason is to avoid the SEC’s regulatory conditions.
A Few Things To Consider
It’s important to recognise that OTC stocks tend to have lower liquidity. Entering and exiting positions may be more difficult if traders are looking for specific prices. Lower liquidity is also associated with increased volatility.
Pay careful attention when placing orders to ensure you execute at your desired price. Read our Stake Academy on Order Types to understand how to best leverage the market, limit and stop orders to execute trades.
How Do I Trade OTC Stocks?