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How Do OTC Stocks Work?

Original post by Alexis Lawrence of Demand Media

Over the counter (OTC) stocks do not generally trade on the same markets as traditional stocks. These stocks, which have lesser values than stocks traded on the stock exchange, trade on the OTCBB, or over the counter bulletin board, or on the pink sheets, though some penny stocks also trade on the NASDAQ.

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What Makes a Stock a Penny Stock?

Despite the name, and the fact that some traders consider any stock that trades for under $1 a penny stock, the characteristics of a penny stock, according to the Securities Division, include trading below $5 per share, having net assets totaling no more than $4 million dollars and having a limited history on the stock market.

How Trades Work

Even though OTC stocks do not trade on the traditional stock exchange, the stocks still trade in basically the same way as traditional stocks. To buy a penny stock, you must put in a buy order with a stock broker, either directly or through a trading website. When the price of the stock reaches the price that you want to pay for the stock, the broker makes the purchase. If you want to sell the stock, you must put in a sell order with the broker, and when the stock price reaches the price at which you want to sell, the broker sells the stock.

Why Separate Markets

Since the stock trading process is the same for penny stocks as for non-penny stocks, it may seem as if there’s no reason for keeping penny stocks in a separate market. One major difference separates penny stocks from traditional stocks, however, and that is regulation. In order for a company to trade stock on a major exchange, like the New York Stock Exchange, the company must meet certain financial and other criteria. Penny stock markets, however, have far more lax criteria.

Risks

Due to the lack of standards on the OTCBB and pink sheets, trading penny stocks generally carries more risk than trading stocks on the NYSE or another highly-regulated market. Though many legitimate companies do trade on the pink OTCBB and pink sheets when starting out, due to a low net worth and short trading history, other companies use the lack of regulation to game the system. Some companies may advertise products or services that have no proven success and may only make profits through trading.


                   

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About the Author

Alexis Lawrence is a freelance writer, filmmaker and photographer with extensive experience in digital video, book publishing and graphic design. An avid traveler, Lawrence has visited at least 10 cities on each inhabitable continent. She has attended several universities and holds a Bachelor of Science in English.


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