Fact checked by Yarilet Perez
The process of purchasing or selling over-the-counter (OTC) stocks can be different from trading stocks that are listed on the New York Stock Exchange (NYSE) or the Nasdaq. OTC stocks aren’t listed on the exchange. Purchases of OTC securities are made through market makers who carry an inventory of stocks and bonds that they make available directly to buyers.
Some online brokers allow OTC trades. Full-service brokers offline also can place orders for a client.
Key Takeaways
- Over-the-counter stocks are known as penny stocks because most of them trade for under $5 per share.
- Over-the-counter stocks don’t trade on a regulated exchange such as the NYSE or the Nasdaq.
- They can be traded through a full-service broker or some discount online brokerages.
- Many companies that trade over the counter are believed to have great potential because they’re developing a new product or technology.
What Are Over-the-Counter (OTC) Stocks?
Over-the-counter stocks don’t trade on a regulated exchange such as the NYSE or the Nasdaq. They’re trading OTC in most cases because they don’t meet the stringent listing requirements of the major stock exchanges.
Tens of thousands of small and micro-capitalization companies are traded over the counter around the world. Many companies that trade over the counter are seen as having great potential because they’re developing a new product or technology or conducting promising research and development.
Others trading OTC were listed on an exchange for some years only to be delisted. A stock can be automatically delisted if its price falls below $1 per share. Those shares need to trade somewhere if the company is still solvent.
How OTC Stocks Are Different
OTC stocks are known as penny stocks because they generally trade for less than $5 per share. The companies that sell them usually have a market capitalization of $50 million or less.
Penny stocks have always had a loyal following among investors who like getting a large number of shares for a small amount of money. The investor ends up making a bundle if the company turns out to be successful. The loss is hopefully a small one if it doesn’t.
Potential investors should be aware that these companies aren’t required to provide a lot of information about their finances, their business operations, or their products as is required for companies that are listed on the regulated stock exchanges. It’s important to take their statements with a grain of salt and do your research.
How to Trade OTC Stocks
The first step an investor must make before trading OTC securities is to open an account with a brokerage firm. Check first to make sure it allows OTC trades if you’re going with an online discount broker. Interactive Brokers, TradeStation, and Zacks Trade are among those that do.
10,000+
The number of stocks trading on the over-the-counter market.
You can buy and sell OTC stocks if you go with a real-world, full-service brokerage. The broker will place the order with the market maker for the stock you want to buy or sell. The process is the same as it is for investors with any stock transaction. They can place limit or stop orders to implement price limits.
Most common stocks with real potential are priced over $15 per share and are listed on the NYSE or Nasdaq. Stocks priced below $5 that trade over the counter may have murkier financial outlooks and are generally speculative and very risky.
Most successful stocks such as Microsoft (MSFT), Meta (META), formerly Facebook, and Tesla (TSLA), all first listed their shares on the NYSE or Nasdaq with prices above $10.
Important
Both stocks and bonds can be traded over the counter.
Can Investors Short Sell OTC Stocks?
Short selling is allowed on securities traded over-the-counter but it isn’t without potential problems.
These stocks generally trade in low volumes and this makes them Illiquid. An investor trying to cover an unprofitable short position could get stuck.
OTC securities have also been the focus of pump-and-dump schemes. Con artists use social media and email to heavily promote a thinly-traded stock in which they have an interest. This can create a high spike in the price of the stock. The con artists grab their profits and everyone else loses money.
These schemes often use OTC stocks because they’re relatively unknown and unmonitored compared to exchange-traded stocks.
Can Exchange-Traded Stocks Also Trade OTC?
They can and they sometimes do, particularly when thousands of shares are involved. Trading over the counter gives institutional investors a certain degree of anonymity, at least in the early stages of the process. This can help prevent price swings.
What Are Pink Sheets?
OTC stocks are sometimes referred to as “pink sheet” listings. Small, new, and unsubstantiated companies tend to issue these stocks because they allow them to dodge the financial disclosure rules required by the stock exchanges.
What Are Some Risks of OTC Stocks?
You’re effectively trading blind when you invest in OTC stocks because of the lack of required financial disclosure. This lack of disclosure can increase the risk of a company’s default. These stocks also tend to suffer low liquidity.
The Bottom Line
Over-the-counter stocks aren’t listed on the New York Stock Exchange, the Nasdaq, or any other regulated exchange. These companies are unregulated and are often smaller, newer, and provide unsubstantiated data. This comes with both pros and cons. They’re typically much less expensive to trade but they’re also riskier.
Be sure to do your homework before venturing into any new trading arena.
Disclosure: Investopedia does not provide investment advice; investors should consider their risk tolerance and investment objectives before making investment decisions.