OTC Markets: What It Is, How to Trade It, & Pros and Cons

If you’re learning about penny stocks, you know many trade on the over-the-counter, or OTC, markets. 

That’s a broad term for trading marketplaces that aren’t stock exchanges. The companies that trade on them are known as OTC stocks. But what does that mean?

Yahoo Finance lists these companies as “Other OTC,” but OTC’s meaning goes beyond that. These broker-dealer networks have a rich history. Traders have made and lost fortunes on them.*

OTC markets are sometimes cast as the seedy underbelly of the stock market. If the major exchanges are a mall, the OTC markets are a foreign bazaar. 

There are dangers with all trading, but OTCs carry extra risk for the uninformed. So this guide is designed to help you understand OTC markets.

What are OTC stocks? How do they trade? How do they differ from listed stocks?

For answers to these questions and more, read on! 

What Are OTC Markets?

OTC markets are off-exchange markets for broker-dealer networks that allow participants to buy and sell shares. 

There are two major exchanges in the U.S. There’s the New York Stock Exchange (NYSE) and the Nasdaq. You may have heard of the American Stock Exchange (AMEX). That used to be an exchange, but it’s now owned by the same holding company that owns the NYSE.

The OTC markets are for public securities that don’t trade on those exchanges. 

A broker-dealer is a person or institution that buys and sells securities. Broker-dealers are required to register with the Security Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA). 

A broker-dealer network is a group of broker-dealers working together. 

The OTC markets are a barely regulated, high-risk marketplace where delisted and unlisted stocks trade. If you think of the major exchanges as a bank, the OTC markets are like the alley behind the bank.  

You can scan for OTC stocks on the StocksToTrade platform — and get beautiful charts, built-in scans, news feeds, and so much more. Try it now for 14 days for only $7!  

What Is an OTC Stock?

An OTC stock is a stock that trades on the OTC markets.

Some are shell companies or companies on the verge of bankruptcy — or in bankruptcy. An OTC can be a company that failed to meet its reporting requirements. Companies delisted from the major exchanges can trade as OTC stocks.

You’ll also find decent companies on the OTC markets. The American depositary receipts (ADRs) of many companies trade on OTC markets.

In case you’re wondering how many OTC stocks there are, the number is about 10,000. 

What Is the OTC Markets Group?

OTC Markets Group Inc. (OTCQX: OTCM) is a company, not a marketplace. It’s an example of a healthy OTC company. It offers an electronic trading system for broker-dealers. 

It’s changed its name a few times since it formed — it was originally the National Quotation Bureau — but it’s always worked in OTC trading. 

In 1999, it became the first company to bring electronic quotation services to the OTC markets. 

These days, in addition to providing quotation services, OTC Markets provides information. Its website has up-to-date information on news, volume, and price. 

What Is the Marketplace for OTC Stocks?

There are four major OTC marketplaces. Remember, they’re off-exchange markets run by broker-dealer networks. 

There are four groups — OTC Best Market (OTCQX), the OTC Bulletin Board (OTCQB), the pink sheets (OTCPK), and the grey sheets (GREY). 

• The OTC Best Market houses the most legitimate stocks among the OTCs. These are mostly foreign companies and ETFs that aren’t favored by the major exchanges. On the OTCQX you won’t find penny stocks, shell companies, or companies in bankruptcy.
• The Bulletin Board has less regulation. It houses companies that aren’t good enough for the OTC Best Market. The companies here also aren’t delinquent enough to make it to the pink sheets. 
• The pink sheets are where the sketchiest companies wind up — companies that are delinquent on their filings, shell companies, and bankrupt stocks. 
• The grey sheets are where OTCs go to die. These companies are under investigation. Some of them have received the dreaded “caveat emptor” designation. That’s a huge red buyer-beware flag. It’s wise to avoid these stocks. 

When Does the OTC Market Open?

The OTC market opens at the same time as listed exchanges — 9:30 a.m. Eastern. It also closes at the same time — 4 p.m. Eastern.

How Do You Trade on OTC Markets?

With the right broker, you can trade on the OTC markets the same way you can trade on an exchange. Most brokers charge commissions on OTCs — even brokers that are usually commission-free. 

But OTCs don’t trade like listed stocks. A listed stock trades like a live auction, with buyers and sellers matching when they agree on a price. OTCs are more like shady, back-door deals. 

You tell your broker you’ll buy a stock for four bucks. The broker sends your order into the network. If your order fills, the dealer sells you the stock for four bucks. 

An OTC security doesn’t transfer to you from another trader. It’s transferred from someone to the dealer. The dealer then transfers the stock to you.

I know it’s a slight nuance, but it makes a difference in how the securities trade. 

It slows down trading. As a result, OTCs tend to trend cleaner. You often see several minutes of movement in one direction before the price changes. Compare that to a listed stock, where the price action can get choppy. You might see big pulls on an upward move, all in the same minute. That doesn’t happen as often with OTCs. 

What Type of Stocks Can You Trade Over the Counter?

All kinds of stocks — sketchy and otherwise — can trade in the OTC world. 

That’s why some companies prefer to keep their stocks unlisted. Once a stock gets to a major exchange, it’s heavily regulated. Stocks that trade over the counter face minimal regulation. 

In the modern world, we’ve digitized everything. Almost all transactions happen over a network. It wasn’t always like that. 

Once upon a time, stocks traded on slips of paper. That’s how the pink sheets got their name. Trading involved actual pink sheets. Boiler rooms would sell massive volumes of these stocks over the phone to people at home. 

At that time, you could buy shares from your buddy in a coffee shop or a bar. Of course, we’re still talking about companies with little to no regulation. It wasn’t as easy to make sketchy deals with listed companies, though it still happened. 

“Over the counter” is a term reminiscent of years gone by. It’s a holdover from a time when you could actually buy shares over the counter. 

Types of OTC Market Securities

Many kinds of trading vehicles — securities — exist in the OTC markets. 

There are ADRs, treasury bonds, mutual bonds, warrants, and of course, stocks. 

How to Buy OTC Stocks

Here are a few things traders need when buying OTC stocks:

• an OTC-compatible broker
• a catalyst
• plenty of liquidity 
• and above all, a trading plan

Remember that OTCs are the underbelly of the stock market, where many companies go to die. If you wind up holding the bag on some of these OTCs, you could be holding the bag for life.

That said, with the right broker, you can buy one like any other stock. Put in your limit order and click the “buy” button. 

It’s critical to use limit orders when trading OTCs. If you place a market order with an OTC, you can wind up paying any price for the stock — and it likely won’t be in your favor. 

If you watch Level 2 on an OTC, you may see something strange. There’s usually a seller at a much higher price than the current action. Now, if you place a market buy order and you get routed to that broker-dealer — well, you might be the one taking that offer. 

How to Sell OTC Stocks

Selling OTCs is like buying them, but you’re clicking “sell.” Again, it’s important to use a limit order here. Liquidity is even more important, though. 

When you’re buying an OTC, you’re the liquidity. When you’re selling the stock, you have to have a buyer. It’s critical that you sell before liquidity dries up. 

Once the volume fades — once the party’s over — you don’t want to be the one left with shares.  

I can’t overstate the importance of liquidity. That’s why I’ve teamed up with two pro traders to help alert liquid stocks and possible plays. Sign up for Small Cap Rockets here — and get access to killer alerts with market insight!

Five Advantages of OTC Markets

Despite the dangers of the OTC markets, there are a few advantages… 

• Dirt-cheap stocks allow you to take bigger positions. 
• Low prices can mean the potential for big percent moves. 
• A 10-cent move on a $1 stock is only 10%. A one-cent move on a one-cent stock is 100% — meaning your position value can potentially increase much faster.
• Since OTCs are usually illiquid, it doesn’t take as much volume to move them.
• The broker-dealer system causes orders to stack up. This can make Level 2 easier to read and trends easier to follow. 

Five Disadvantages of OTC Markets

I said these stocks can be shady … Here are a few hazards in the OTC markets.

• Lack of regulation leads to shady deals and questionable practices. 
• Manipulation is easier and more frequent due to fewer regulations. 
• When volume dies in the OTC market, it can stay dead for a long time.
• Orders can take longer to fill — if they’re filled at all. 
• If you’re determined to get your limit order filled, you may have to place it well above the bid or ask. You may not be able to get in and out at your preferred price.

Regulations of the Over-the-Counter Market

FINRA provides oversight for trading on the OTC market and issues trading symbols. It requires public companies to report splits, reverse splits, name changes, and mergers. 

FINRA also regulates the OTC Bulletin Board and OTC Link ATS. Those are systems through which broker-dealers post price and volume. Only broker-dealers qualified with FINRA are allowed to apply to quote securities. 

To list on the OTC exchanges, companies must have FINRA-approved broker-dealer sponsors. And they must have at least three broker-dealers willing to trade the security. 

I know that’s a lot to take in. It would be a lot to explain in this short blog post. If you want to learn more, check out FINRA’s website. 

Examples of OTC Stocks

I want to give you a couple of examples of OTC stocks from 2020. Keep in mind that these are only examples of these stocks and how they operate. This is not trading advice.

Columbia Care Inc. (OTCQX: CCHWF) is a cannabis company. The weed sector started heating up in the fourth quarter of 2020. Because it trades on the OTC Best Market, it’s considered safer than those on the bulletin board or pink sheets. That doesn’t mean it’s a safer stock. It means it meets certain requirements. 

Jupiter Gold Corp. (OTCQB: JUPGF) is a Brazillian company focused on gold exploration and discovery. As you can see from this yearly chart, OTCs can be very illiquid. This stock didn’t trade one million shares all last year.

LATAM Airlines Group S.A. ADR (OTCPK: LTMAQ) represents the ADRs of LATAM Airlines Group S.A. It’s a South American airline company.  

Are Over-the-Counter Stocks Safe?

All trading is risky. For any trading strategy, it’s important to have good risk management. For any trade you take, have a plan and stick to it. 

The OTC markets can be a dangerous place for traders, and the exchanges have tiered risk. 

• The OTC Best Market (OTCQX) is the safest, most regulated of the OTC markets. 
• Then there’s the OTC Bulletin Board (OTCQB) which carries mid-tiered companies with relatively less risk than pink sheets.
• And the OTC pink sheets (OTCPK) are risky companies. Think shell companies, companies in bankruptcy, companies with poor filing practices, etc. 
• The OTC grey sheets (GREY or “OTC Other”) are the riskiest. These are companies under investigation for fraud. Some of them have had their offices raided by the FBI. Many have earned the “caveat emptor” designation.

These blanket statements make it easy to compartmentalize … but it’s important to be cautious. A company can trade on the Best Market and still be risky. Maybe they haven’t been caught doing something nefarious. It doesn’t mean they won’t. 

Always use your better judgment, and do your research.

Check out this SteadyTrade podcast with Jack Kellogg as he talks about trading OTCs.

The OTC Markets Conclusion

Sometimes a company doesn’t meet the listing requirements for major exchanges. Or they might meet listing requirements, but management doesn’t want to pay listing fees. Sketchy companies stay off the listed exchanges to avoid scrutiny and regulation. 

These are all reasons why a company’s stock might trade on the OTC markets. The OTC markets don’t work the same as major exchanges. Broker-dealers run the networks. They buy and sell orders instead of matching buyers and sellers. 

Four networks carry tiered risk. The stakes are high, but the potential for tremendous gains is there. You’ll need the right broker.

On the SteadyTrade Team, we tend to talk more about listed stocks. But Mike “Huddie” Hudson is our resident OTC specialist. He gives weekly webinars, which are all archived so you can enjoy them any time.

2021 is a wild year so far! You don’t have to go it alone. Apply to join the SteadyTrade Team today. 

What’s your experience with OTCs? Which OTC trades are you considering? Leave a comment below! We love hearing from you.