Over-the-counter (OTC) markets are stock exchanges where stocks that aren't listed on major exchanges such as the New York Stock Exchange (NYSE) can be traded. About 12,400 stocks trade over the counter. The companies that issue these stocks choose to trade this way for a variety of reasons.
Here's a rundown of how the over-the-counter stock markets work and the types of securities you might find on the OTC markets. We'll also discuss some other key information you should know before you decide whether OTC stocks are right for you.
What are the over-the-counter (OTC) markets?
Historically, the phrase trading over the counter referred to securities changing hands between two parties without the involvement of a stock exchange. However, in the U.S., over-the-counter trading is now conducted on separate exchanges.
Over-the-Counter (OTC)
Pros and cons of investing in OTC markets
Like any type of investment, putting your money into stocks that trade on the OTC markets has advantages and potential drawbacks. A wide variety of companies trade on the OTC markets, so it's unfair to generalize all OTC stocks. However, there are some general pros and cons to consider. Here are a few:
Pros of OTC Markets | Cons of OTC Markets |
|---|---|
Ability to invest in earlier-stage companies that aren't big enough to trade on the NYSE or Nasdaq. | Lower barriers to entry than major markets, which leads to increased fraud, especially in the Pink Sheets market. |
Ability to invest in foreign companies that primarily trade on non-U.S. stock exchanges. | OTC stocks can be thinly traded and less liquid than NYSE- and Nasdaq-listed securities. It's also common to see significantly wider bid/ask spreads in OTC stocks for this reason. |
Ability to invest in companies that are unable to list on a major U.S. exchange, such as most marijuana stocks. | Less strict reporting standards than major exchanges, which means investors have less visibility into a company's operations. |
Examples of over-the-counter securities
A few types of securities that trade on the OTC markets can potentially make good investments.
For example, you'll often find international stocks (including many large and well-known companies) listed on the OTC markets. Stocks listed on U.S. exchanges that primarily trade in foreign markets are known as American Depository Receipts, or ADRs.
Samsung Electronics (SSNL.F +56.02%) is one great example. The electronics giant has a market cap of more than $250 billion (USD equivalent) and trades primarily on the Korea Exchange. So, unless you have a brokerage account that allows you to buy stock on foreign markets, you'll have to buy the OTC version.
You'll also find stocks on the OTC markets that cannot list on the NYSE or the Nasdaq for legal or regulatory reasons.
Finally, many stocks list on the OTC markets simply because they're too small or too thinly traded to meet the standards of larger exchanges. Many of these companies plan to list on either the NYSE or the Nasdaq as they grow. For example, Walmart (WMT +0.17%) was an OTC stock from 1970-72, when the company was still a relatively small retail chain.
Other major exchanges
How to buy OTC stocks
The process of buying OTC stocks is relatively easy. Because they trade like most other stocks, you can buy and sell OTC stocks through most major online brokers.
To buy shares of an OTC stock, you'll need to know the company's ticker symbol and have enough money in your brokerage account to buy the desired number of shares. It's worth noting that brokers may have special margin requirements and other restrictions with OTC stocks. For example, OTC stocks might not be eligible for fractional share trading.
Should you buy OTC stocks?
Although it’s easy to buy OTC stocks, the tougher question to answer is whether you should buy OTC stocks.
As we've seen, some types of stocks trade on the OTC markets for very good reasons, and they could make excellent investment opportunities. On the other hand, many OTC stocks are issued by highly speculative businesses or even outright fraudulent companies involved in pump-and-dump scams.
As long as you understand the OTC marketplace and do your research on the stocks that interest you, you can avoid scams and other bad investments on the OTC and focus on finding solid long-term investments.
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