Nothing ventured, nothing gained – it’s a saying that’s gotten plenty of mileage in the business world. And it’s easy to see why – if you do what everybody does, how can you expect to get anything other than mediocre results?
This maxim also holds true in investing. If you park your cash in bonds, you shouldn’t expect to get 10%+ annual returns. Want to do better than that? Then you’ll have to take on more risk.
Penny stocks definitely fall in the riskier basket. For the most part, you’ll primarily find these equities on the over-the counter, or OTC markets. However, this marketplace (and penny stocks in general) have risks that many novice traders don’t fully appreciate.
That’s why we’ve written this guide. Below, we’ll fill you in on the basics of OTC markets and penny stock trading. Let’s jump right into it.
What Are OTC Markets?
Unlike the Dow Jones or the NASDAQ, the OTC markets are not a stock exchange. Instead, they are a decentralized network of dealers. Before the internet, traders made OTC trades over the phone, but these days, most are completed electronically.
OTC markets also differ from mainstream exchanges on the subject of regulation. Before an exchange like NASDAQ accepts listings, applicants must go through a time and money-consuming process.
On the OTC markets, the application process is far shorter and much more affordable. And depending on how a company lists itself, it might not need to comply with SEC reporting guidelines. Because of this, many cash-starved startups opt to go the OTC route to avoid surrendering creative control to venture capitalists.
What Are Penny Stocks?
If you go by the SEC definition, then penny stocks are equities that trade for less than $5 per share. However, for most, a penny stock is an equity that trades for below $1 per share. Because of their affordability, that means buyers can pick up vast quantities of stock for a bargain price.
However, you won’t find these stocks on mainstream exchanges. On the Dow Jones, S&P 500, NASDAQ, and other top trading platforms, stocks usually get delisted when they fall below $1/share.
So if you want to go hunting for sub-dollar penny stocks, the OTC markets are where the action is at.
OTC Investing Comes With Real Risks
Don’t be so fast to jump in the water, though – both the OTC markets and penny stocks have a checkered reputation. So before we teach you how to trade OTC penny stocks, let’s assess the risks first.
As we touched on earlier, the OTC markets are less regulated than mainstream exchanges. While some sectors (OTCQX, OTCQB) follow SEC rules precisely, not all do. For instance, companies listed on the “pink sheets” report data voluntarily. For this reason, many pink sheet companies have data sets that are incomplete or out-of-date.
And then there are “grey sheet” companies. These firms report no data – beyond their name and stock ticker, of course. Often, pump-and-dump scammers target these firms, as their lack of data makes it impossible for their victims to research.
Lack of market liquidity is another significant danger to those trading on the OTC markets. In mainstream exchanges, massive investment banks (like Goldman Sachs) act as market makers. That is, they help facilitate trades that market participants themselves may not be able to fund immediately.
In the OTC markets, there are no big Wall Street investment firms greasing the wheels. Instead, the dealers themselves act as market makers. As you can appreciate, this can cause serious problems when an OTC stock is making big moves. On the way up, you may have problems entering at your preferred price.
But it’s worse on the way down – when an OTC stock is plunging, scarce liquidity can make it tough for you to quickly exit your position quickly. Because of this, you can lose far more than anticipated.
Before investing a dime in OTC markets, ensure you fully understand these risks.
How to do Research on OTC Stocks
Now that you’re aware of the dangers of OTC investing, let’s tackle the next biggest issue – picking penny stocks. Researching micro-caps can be challenging, as not all are OTCQX/OTCQB companies. Outside these listings, you can still find promising firms in the “pink sheets”, but you’ll have to double down on qualitative research to make up for incomplete/outdated data.
But do consider whatever data is available. If you don’t understand what’s in front of you, take trading courses on Udemy. They should teach you how to read a financial statement, how to do technical analysis, and so on. Afterwards, you should find it easier to uncover stocks that are undervalued, spot pump-and-dumps, etc.
For additional insight, search for your stock on micro-cap investing blogs like Insider Financial. This way, you’ll get a second opinion on your equity, as well as the industry in question.
But don’t rely on these sources too heavily. There is no replacement for building your own investing skill sets – hone them, and they’ll serve you well throughout your career.
How do I Buy on the OTC Markets?
So the big day has arrived – you’re ready to buy your first OTC penny stock. But how? A couple of decades ago, you would have to pick up the phone and call an OTC dealer. But today, virtually all OTC trades are executed electronically.
In recent years, leading online brokerages have added OTC trading to their platforms. So, all you have to do is sign into your broker and search for your penny stock’s ticker. However, not all brokerages offer OTC – if yours doesn’t, you may have to open a second account with another trading platform.
Once you’ve found your stock, fill your order, then hit submit. Congratulations – you just successfully purchased penny stocks on the OTC markets.
Get Your Feet Wet – But Don’t Jump in Blind
If you play your cards right, you can make a tidy profit trading OTC penny stocks. But most end up losing their shirt. But that’s because they jump in blind without doing any research. Their lottery mentality is their trading philosophy – an approach that bleeds cash over the long run.
But if you learn market fundamentals and do your due diligence, you’ll win more than you lose. Make no mistake, though – your road to success will be a bumpy one. But stick to it, and you’ll get there in time.