Trading via OTC is particularly appealing to those looking at companies who are small and developing; however, there are several factors and resources to be aware of when looking into the OTC market and finding a reliable broker.
OTC stocks encompass a broad array of stocks ranging from small to big, foreign or domestic, and legitimate to illegitimate. Penny stocks encompass small, public companies trading at less than $5 per share. The low-cost, high-return potential of penny stocks makes them popular among investors, but because there are less regulations in the OTC market, there is a higher potential for fraud.
The bulk of the research that should be acquired prior to investing in an OTC stock lies in the stockbroker and the company itself. Much like finding a credit card company, finding a reliable broker requires a careful assessment of things like account minimums and hidden fees. E-trade and TD Ameritrade are both brokers with low minimum balance requirements.
In addition to researching both the quality and quantity of information reported on a stock via OTC Markets Group, it is even more critical to invest with a broker that provides its own thorough and reliable research on the stocks you may be interested in.
Though it is generally recommended to start investing in small amounts, it is beneficial to consider accepting discounts offered for high-volume trades. Brokers like Ally Invest can be useful in keeping the costs low for such trades.
Do your research. Use tools like OTC Markets Group to gauge which companies are providing the most extensive and reliable information. Request a copy of the company’s financial statements if you are unsure, and be wary of companies with minimal information and reporting, as they can often be fraudulent or lead to a large loss through “pump-and-dump” schemes.
Choose a reliable broker. A strong broker will already have done the research on the company you wish to invest in and can readily provide that information.
Invest in small amounts, keeping in mind that OTC stocks have a low volume and low liquidity.
Use traditional risk management strategies like planning entries and exits and using limit orders.
For step-by-step instructions on purchasing stocks through the brokers discussed in this article, consult the links below:
TD AmeriTrade: https://www.youtube.com/watch?v=70zKa36agGU
Risks of Investing in OTC Stocks
Depending on the type of OTC stock, some may pose a greater risk of fraud or loss than others. Because the reporting requirements are different for OTC stocks, it is important to understand how to differentiate a legitimate company from one which provides minimal information. OTC Markets Group ranks stocks based on who provides the most regulatory reporting, allowing the investor to make a more informed decision. The site also provides information on red flags to look out for such as fraudulent activity and bankruptcy.
Because of their low volume, OTC stocks also have less trade liquidity. Consequently, it can be harder to buy and sell quickly without a price change. In short, the low volume and low liquidity of a stock means a loss in money.
The most common fraud scheme associated with penny stocks is referred to as “pump-and-dump,” where stocks are promoted in order to drive up the price and then sold to traders, resulting in a hefty price drop. This is why researching a company is critical to ensuring its legitimacy.