If you're thinking of investing in a stock that trades in the over-the-counter market, be prepared for some ups and downs. The OTC market is a platform for stocks that are kind of the misfits of the stock market. OTC stocks don't meet the high standards required by the major exchanges, such as the New York Stock Exchange and Nasdaq. An investment in an OTC stock means more volatility or price movements, and less stock price transparency, that you'd get from stocks in the more regulated major exchanges.
More than 3,000 financial securities -- including domestic and foreign stocks -- are traded in the OTC markets. The stocks that trade in the OTC markets are those of companies that either are too small or don't have the financial wherewithal to be listed on a major exchange. The stock market's smallest companies -- known as micro-cap stocks -- list their shares in the OTC markets and could trade for only pennies per share. The smaller a company is, the more of a risk its stock is to investors. That's because when the economy slows or a company's sales take a hit, small companies have fewer resources to draw on than do larger, more established businesses.
On the NYSE Euronext or Nasdaq, you're going to run into the stocks of companies that are household names. Some of the largest companies in the world, in industries ranging from high-tech to health care, list their shares on both of these exchanges. Approximately 2,800 stocks are traded on the NYSE Euronext and 2,852 stocks are listed on Nasdaq. These stocks are pricier than those that list in the OTC markets. And they can't let their stock price dip too low for too long without a risk of being kicked off the exchange. At NYSE Euronext and Nasdaq, that minimum is $1 per share.
Liquidity is lighter in the OTC market. That means that if you're looking to sell shares of a stock you own in the OTC market, you might not be able to cash in as quickly as you'd like. There are fewer market participants, known as dealers in the OTC markets, performing trades for investors. Sometimes you might have to just wait to buy or sell a stock.
You aren't likely to run into the same problem with NYSE or Nasdaq-listed stocks, where in the first nine months of 2011 the average daily trading volume surpassed 2 billion shares at each exchange. Numerous market specialists perform trades on those exchanges, and billions of dollars worth of stocks are bought and sold each trading day.
The OTC markets don't turn away companies that have become insolvent and filed for bankruptcy protection. However, the OTC markets do alert you about a company in bankruptcy, with a letter Q attached to the end of the stock's trading symbol.
On a major exchange, you don't have to worry about investing in an insolvent company. If an NYSE or Nasdaq stock goes bankrupt, its shares usually won't be listed on either exchange much longer.
- U.S. Securities and Exchange Commission: Corporate Bankruptcy
- New York Stock Exchange: NYSE to Immediately Suspend Trading in Securities of K-V Pharmaceutical Company / Moves to Remove From the List
- USA Today: Recent Stock Rally's Low Trading Volume Sparks Unreal Fears
- PR Newswire: Suntech Regains Compliance With NYSE Minimum Share Price Listing Requirement
- Nasdaq: Continued Listing Guide
- U.S. Securities and Exchange Commission: Microcap Stock: A Guide for Investors
- International Monetary Fund: Markets: Exchange or Over-the-Counter
- NYSE Euronext: Frequently Asked Questions
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.