What is the Current Thinking on OTC Markets?

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Table of Contents 

 

  • Stock Exchange Stats
  • What is the OTC Market and What Instruments are Traded There?
  • Why are Penny Stocks Largely Traded OTC?
  • Pros and Cons of Trading Penny Stocks OTC

 

Stock Market Stats

The stock markets with the largest market capitalizations in the world include the heavy hitters that are household names to traders and investors. From 1 through 10, here are the top performing stock markets by market cap.

  • New York Stock Exchange – $24.49 trillion market capitalization January 2021
  • NASDAQ – $19.34 trillion market capitalization January 2021
  • Shanghai Stock Exchange – $6.5 trillion market capitalization January 2021
  • Hong Kong Stock Exchange – $6.48 trillion market capitalization January 2021
  • Japan Stock Exchange – $6.35 trillion market capitalization January 2021
  • Shenzhen Stock Exchange – $4.9 trillion market capitalization January 2021
  • Euronext – $4.88 trillion market capitalization January 2021
  • LSE Group – $3.67 trillion market capitalization January 2021
  • National Stock Exchange – $2.57 trillion market capitalization January 2021
  • Toronto Stock Exchange– $2.5 trillion market capitalization January 2021

*Data provided courtesy of Trade Brains

What is the OTC Market and What Instruments are Traded There?

Over-The-Counter securities dealing takes place between the broker-dealer network, rather than a central exchange such as the ones listed above. Typically, OTC networks are not subject to the same stringent reporting rules and requirements of the exchanges. This presents all sorts of credibility challenges to the financial instruments that are listed OTC. Generally, OTC securities trading includes debt instruments, shares, and derivatives. The latter refers to a financial instrument which derives its value from another underlying instrument such as stocks, commodities, indices, forex, Bitcoin and cryptocurrency

It is important to point out that OTC markets can include listed equities on exchanges, as well as equities that aren’t. By and large, many nascent companies (in their infancy stages) and concept companies list OTC, since they don’t meet the requirements of the NASDAQ, the NYSE, the LSE, DAX 40, CAC 30, and others. OTC markets don’t refer to a place per se, they refer to the way in which securities are traded. All securitized assets in the OTC arena are traded through a dealer network, and it’s because this market exists that these financial instruments are available to traders and investors. Up-and-coming companies often list OTC to raise capital through stock sales.

Why Are Penny Stocks Largely Traded OTC?

Over-the-counter equities are stocks that trade OTC. In other words, you can buy and sell the stocks through the broker-dealer network. For those stocks which cannot qualify for listing on exchanges, the OTC markets are the go-to option. Many companies prefer to list OTC, for a variety of reasons. Perhaps they’re going through bankruptcy proceedings, on the verge of bankruptcy, or are looking to raise capital but unable to do so on the formal exchanges. There are lackadaisical requirements for companies trading OTC, and this makes it a particularly questionable arena for many traders and investors. The official stock exchanges have stringent requirements for listing and for staying listed. Chief among them Corporate Governance Requirements, Independence Directors, Audit Committee Charter, Audit Committee Composition, Compensation Committees, et al. 

The over-the-counter market is generally divided up into 4 marketplaces, each of which are run by broker-dealer networks. Traders and investors are encouraged to understand how the broker-dealer network functions. And it is the reputable brokers who are best positioned to offer sage trading advice on how to buy OTC stocks. The major marketplaces include the following: 

  • OTC Best Market Houses – overseas companies and exchange traded funds that don’t make it onto the major exchanges, but largely legitimate stocks.
  • Bulletin Board – less regulation involved than the OTC Best Market Houses
  • Pink Sheets – this is where dodgy companies and many penny stocks list
  • Grey Sheets – this is the death knell for OTC stocks

Penny stocks feature prominently OTC, since the stocks are often trading at pennies, or fractions of pennies per share. The formal definition of a penny stock is any equity that trades under $5 per share, but in OTC markets these are often trip-zero stocks, or cheaper. This naturally lends to the advantages and disadvantages of trading penny stocks OTC. Right off the bat, it’s clear that OTC stocks are much cheaper to trade, and potentially have much more upward momentum. Consider a stock that is trading at 1000th of a cent, and it rises to 1 cent in value. Mature stocks such as Google, Facebook, Amazon, Tesla, and others have the propensity to rise in value, but not to the extent that a dirt cheap penny stock can within minutes, hours or days.

Pros and Cons of Penny Stocks Trading OTC

The inherent attractiveness of penny stocks trading OTC (vis-a-vis upward price potential) is the biggest draw card. While a 10% price movement in a penny stock or a blue-chip stock is identical, a one penny price movement in a one penny stock represents a 100% appreciation in a penny stock, but a near-zero movement in a $100 stock. That’s the reason why traders tend to prefer penny stocks for rapid ROI generation. Minimum volume is required to move the prices of penny stocks higher, as opposed to blue-chip stocks which need massive volume for price movements.

There are downsides as well. For starters, the lack of oversight and regulatory frameworks means that any charlatan company can present itself as a reputable company and dupe traders and investors. When volume tapers off, the penny stock may become moribund. It’s also more difficult for limit orders to be filled with OTC penny stocks since pricing considerations are difficult to fulfil. The sheer number of OTC stocks is mind-boggling, since many up-and-coming companies and existing companies seek to reel in traders and investors to generate capital for their business enterprises. As a rule, it’s best to stick with the OTC Best Market (OTCQX) since it is the most regulated of the four.

Disclaimer: This content does not necessarily represent the views of IWB.

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