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Feb 14, 2022

What’s an OTC Stock? Low Prices, Risky Business

By Stash Team

Over-the-counter stocks are fascinating—and can be financially fraught. Limited regulation and high volatility might make OTC stocks risky business.

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Ever wondered what OTC stocks (over the counter stocks) are and how to buy them? OTC stocks—sometimes called penny stocks, a type of microcap—are low-priced stocks that don’t trade on stock exchanges. Instead, they trade “over-the-counter,” that is, through specialized traders. OTC stocks can be appealing to investors because of the low per-share cost, but these stocks typically represent high risk levels—both because of the potential for volatility and fraud. 

How does stock trading work?

Trading refers to the mechanism for buying and selling stock—also known as shares. Stocks are little bits of ownership in a company. Investors can trade stocks in two ways:

  • on an exchange, such as the NYSE or Nasdaq
  • over-the-counter (OTC)

There are a number of requirements for being listed on a stock exchange, and the stipulations vary among exchanges. For example, most exchanges mandate that a company’s stock price exceeds $1 per share to be listed initially and remain listed on the exchange, plus require that the stock meets a minimum market capitalization.

Sometimes, a stock might not live up to the requirements to get listed on an exchange—and listed stock can be delisted if it no longer meets the conditions. A delisted stock’s ticker is typically changed to a five letter symbol. For example, if the ticker was CRC when it traded on an exchange, the new ticker might be CRCQQ.

What’s an OTC stock?

Trading of OTC stocks is conducted by wholesale traders and market makers who specialize in buying and selling OTC stocks. These institutions either match buy and sell orders from investors or fill orders from their own inventory after investors choose what OTC stock to buy. 

If you’d like to learn more about the networks some dealers use for trading, the Financial Industry Regulatory Authority (FINRA) website offers a great deal of information. FINRA is a self-regulatory, membership-based organization.

What are the risks if you buy OTC stock?

Before you start making a plan for how to buy OTC stock, you may want to be aware that these stocks are almost always considered a high-risk investment. What an OTC stock seems to offer is an accessible way to start investing, but Stash recommends avoiding OTC investments altogether due to the high risks.

Some people, however, feel enticed by the idea of “penny stocks”—most of which are OTC stocks—and the allure of very low share prices. If you think you might want to buy OTC stock, you may want to carefully consider several risks:

  • Lack of information. It can be difficult to get complete information about OTC stocks, which makes buyers more vulnerable to bad investments. Why? Companies whose stocks trade OTC are subject to fewer reporting requirements and regulations than exchange-traded stocks, although recent regulatory changes are intended to provide more information to investors.
  • Unclear cost. In some cases, the price an investor receives when they buy or sell an OTC stock may vary significantly from the last price at which it traded.
  • Greater volatility. OTC stocks generally have fewer investors trying to buy or sell at any given time. Limited demand reduces their liquidity—meaning it’s harder to convert the stock you own to cash by selling it—which drives volatility.
  • Fraud and scams. Due to minimal reporting requirements and the limited liquidity of OTC stocks, investors may be more vulnerable to price manipulation and potential fraud. The SEC has identified a number of red flags that may help investors spot OTC stock fraud. 

Your portfolio: What’s OTC stock got to do with it?

Ultimately, your investment decisions are your own, and all investing involves the risk that you could lose money. If you choose to include OTC stock in your portfolio, extreme caution is generally warranted. 
Knowing the risks, what’s an OTC stock have going for it? For many people, the appeal may simply be the sense of accessibility. When you see stocks like Alphabet Inc. (owner of Google)  trading above $2,000 per share (as of October, 2021), it can feel daunting to start investing. But you don’t have to start with a large sum to get in the investing game with OTC stocks. An alternative to investing in an OTC stock is to invest in fractional shares, where you buy pieces of shares—even high-value stocks traded on an exchange. With a Stash account, you can start investing in fractional shares (as well as exchange-traded funds) with any amount of money. Because having access to investing shouldn’t mean you have to take on more risk than you’re comfortable with.

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