Why are OTC stocks risky?
OTC stocks have less liquidity than their exchange-traded peers, low trading volume, larger spreads between the bid price and the ask price, and little publicly available information. This results in them being volatile investments that are usually speculative in nature.
OTC stocks have less trade liquidity due to low volume which leads to delays in finalizing the trade and wide bid-ask spreads. Less regulation leads to less available public information, the chance of outdated information, and the possibility of fraud.
OTC markets require different, varying financial reporting. This lack of transparency makes it easier for fraudsters to manipulate information and misrepresent financials. If paired with unscrupulous stock promoters making exaggerated claims, investors can become victims.
You are unlikely to get rich trading penny stocks. On the contrary, you are much more likely to lose your money. Penny stocks and OTC stocks have an average negative annual return of 24%. Over 90% of penny stocks fail.
Additionally, the lack of regulation and oversight in OTC markets can also increase the risk of unethical practices and fraud, such as manipulation of pricing or hidden fees.
If a stock falls to or close to zero, it means that the company is effectively bankrupt and has no value to shareholders. “A company typically goes to zero when it becomes bankrupt or is technically insolvent, such as Silicon Valley Bank,” says Darren Sissons, partner and portfolio manager at Campbell, Lee & Ross.
Low liquidity: OTC stocks have less liquidity than those listed on exchanges. The exchange stocks usually have a significantly lower trading volume and bigger spreads between the bid and ask prices. Therefore, OTC stocks are subject to more volatility.
The other major risk in OTC trading is the market for OTC shares is often thinly traded, with wide bid-ask spreads that make it difficult to trade profitably. For example, an OTC stock might trade for $0.05 per share, but with the bid set at $0.05 and the ask set at $0.10.
The OTC market is generally considered to be pretty risky, given the more lenient reporting requirements and lower transparency associated with these securities.
OTC derivative transactions, like other financial transactions, involve a variety of significant risks. The specific risks presented by a particular OTC derivative transaction necessarily depend upon the terms of the transaction and your circ*mstances.
Can OTC stocks be delisted?
Others trading OTC were listed on an exchange for some years, only to be later delisted. A stock may be automatically delisted if its price falls below $1 per share. 12 If the company is still solvent, those shares need to trade somewhere.
But really, it is when a stock upgrades from an alternative stock exchange to a major one. For example, a stock may move from the over-the-counter (OTC) markets — broker-dealer networks that allow people to trade stocks directly — or a small international exchange to the Nasdaq or NYSE.
Do penny stocks ever "go big"? Penny stocks can certainly "go big," but the problem is these parabolic moves are usually short-lived. Penny stocks frequently double or triple in price in short periods, but these companies usually have a very bleak 5-year chart.
The Financial Industry Regulatory Authority (FINRA) regulates broker-dealers that operate in the over-the-counter (OTC) market. Many equity securities, corporate bonds, government securities, and certain derivative products are traded in the OTC market.
For over-the-counter (OTC) equity securities, which are generally stocks that are not listed on an exchange, FINRA issues trading and quotation halts under certain circ*mstances.
In an OTC market, dealers act as market-makers by quoting prices at which they will buy and sell a security, currency, or other financial products. A trade can be executed between two participants in an OTC market without others being aware of the price at which the transaction was completed.
The biggest risk from buying on margin is that you can lose much more money than you initially invested. A decline of 50 percent or more from stocks that were half-funded using borrowed funds, equates to a loss of 100 percent or more in your portfolio, plus interest and commissions.
When the stock market declines, the market value of your stock investment can decline as well. However, because you still own your shares (if you didn't sell them), that value can move back into positive territory when the market changes direction and heads back up. So, you may lose value, but that can be temporary.
While a lot of fanfare may occur when a stock is newly listed on an exchange—especially on the NYSE—there isn't a new initial public offering (IPO). Instead, the stock simply goes from being traded through the OTC market to being traded on the exchange. Depending on the circ*mstances, the stock symbol may change.
In a best-case scenario, a penny stock has likely significantly underperformed the expectations of company management or it wouldn't be trading at such a low share price in the first place. These types of companies can always rebound, but an underperforming company isn't an ideal investment.
Can you make money trading OTC?
The OTC markets give traders access to companies that are growing but aren't yet large enough to be listed on the NASDAQ or NYSE. Investing in a company before it gets listed on a major exchange can yield an incredible ROI.
- Nike (NKE)
- NVIDIA (NVDA) ...
- Monster Beverage Corporation (MNST) ...
- Tractor Supply Company (TSCO) All-Time Return: +54,978% ...
- Axon (AXON) All-Time Return: +48,911% ...
- ASML (ASML) All-Time Return: +30,001% ...
- Netflix (NFLX) All-Time Return: +27,719% ...
- Tesla (TSLA) All-Time Return: +11,641% ...
OTC markets also tend to be more volatile and unpredictable due to the high volume of traders and lack of regulation. While volatility does create opportunity for short-term traders, it's important to have a risk management strategy in place as OTC markets are more likely to be subject to market manipulation.
Lower Costs and Reduced Regulatory Burden
As OTC trades are conducted directly between parties, they can bypass certain fees typically associated with exchange-based trading. Additionally, OTC markets often have less stringent regulatory requirements, which can decrease compliance costs and administrative burdens.
The advantages of OTC markets include low costs, especially when selling new issues, more freedom, and direct electronic transactions. The disadvantages of OTC markets include more risk exposure and a high bid price to ask price spread.
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