Outside mainstream exchanges, you’ll find a whole other world of investing. Thanks to equities like TSNPD, more traders than ever have stumbled across OTC, or over-the-counter stocks. In these markets, double-digit gains are not uncommon.
Unfortunately, for the uninitiated, double-digit losses are not uncommon either. So, before you sink a significant portion of your portfolio into OTC shares, get a lay of the land first. In this post, we’ll cover the basics of investing over-the-counter so you can proceed with confidence.
Let’s get started.
What are OTC Markets?
Unlike traditional stock exchanges (e.g., NYSE, NASDAQ, etc.), OTC markets are fully decentralized. However, they are also less transparent. For example, in an OTC transaction, only the dealer and the buyer know an equity’s sales price. Meanwhile, on exchanges, everyone can see the prices of transactions.
Thanks to fewer listing requirements, OTC markets are fast becoming a source of funding for startups. There’s far less paperwork involved, and the financial costs of going public via OTC is also much lower.
While that’s an excellent deal for businesses, it jacks investor risk through the roof. Because of the lack of transparency in OTC markets, it’s tough to gauge a company’s health. Also, dealers are the market makers in OTC platforms – not investment banks. As a result, available liquidity is far lower than on traditional exchanges.
Carve Out an OTC Bankroll
You can make a tidy sum trading on OTC platforms. However, doing so involves taking on significant risk. Without warning, equities in these markets can plunge 20%, 50%, or even 80%.
So, when you begin trading OTC, start small. Dedicate no more than 2% of your total assets to these equities. That way, if things go south on you, it won’t do lasting damage to your life savings. Once you learn more about these stocks and OTC transactions, you can slowly increase your risk tolerance. However, we recommend limiting your OTC exposure to 10% of your portfolio.
Lastly, do not invest funds needed for essential functions (rent/mortgage, food, etc.). Even if a stock appears to be “going to the moon”, it can always nosedive.
How Do I Find Good OTC Stocks?
Researching most publicly-traded companies is fairly easy. Stock exchanges require firms listed on their platform to disclose financial, managerial, and operational information. Traders can find this data on the “Investor Relations” section of any public firm’s website. With a couple of hours of in-depth research, you can determine if that equity is worth buying.
Doing your due diligence on OTC stocks is much harder. As we mentioned earlier, firms on these trading platforms are subject to far fewer regulations regarding disclosure. In fact, these companies don’t have to supply any information (although doing so marks them as a “dark” or a “toxic” tier firm).
However, not all companies on OTC platforms are scams. By focusing on firms listed in the “trusted” or “transparent” tier, you can greatly reduce your risk. To achieve this rank, businesses must either meet the standards of the NYSE/NASDAQ (trusted) or meet SEC reporting standards (transparent).
If you’re new to analyzing quarterly reports, though, it’s advisable to have access to a trusted second opinion. Websites like Insider Financial make it easier to learn how to find OTC stocksby supplying in-depth commentary.
Buying OTC is Easy
Ready to put your stock-picking intuition to good use? Great – now, all you need is somewhere to buy/sell OTC. In the past, that meant picking up the phone and calling a broker that dealt in OTC securities. Today, though, it couldn’t be easier, as many major online brokerages offer OTC trades.
These big names include platforms like TD Ameritrade, Fidelity Investments, and Charles Schwab. In particular, TD and Schwab offer OTC trades for as low as $0 per transaction. If you’re starting on your trading journey, you should chase deals like these. After all, every penny you save is a penny that you can re-invest into a winning play.
Should I Hold or Sell My OTC Stocks?
This is the question that separates the dabblers from the pros. Like all other securities, every OTC stock is different. And not only are they different, but so are the economic circumstances surrounding each equity. When the economy is hot, resource plays do well. When it’s ice-cold, auction firms and bankruptcy trustees thrive.
And then, you need to consider your own needs and wants. Are you investing for the long run, or are you looking to make a quick buck? All the factors mentioned will play into deciding whether to buy, hold, or sell any OTC stock.
Knowing what to do is a skill you’ll develop over time. Only by trading, assessing, and learning can you make this happen.
Be Extra Cautious With Your OTC Investments
Successful OTC traders can post some seriously brag-worthy gains. But chances are, they’ve suffered crushing defeats in their past. In the beginning, limit your downside risks and focus on learning.
As your confidence grows, slowly expand your risk tolerance. Yes, you’ll get the occasional bloody nose, but when you hit your first big win, the preceding pain will be worth it.