Investing in an OTC stock can lead to big losses. So only buy the most speculative of these stocks with money you are prepared to lose

An OTC stock, or over-the-counter stock, involves shares of companies that are traded on the over the counter market by “market makers” or traders who aim to maintain an orderly market in a particular stock by standing ready to buy or sell shares.

When a company does not meet the listing requirements of an exchange like NASDAQ or New York they will typically be traded on over the counter markets.

Most companies who trade over-the-counter don’t meet the minimum criteria for capitalization, the number of shareholders, and so on that are required by major stock exchanges. An OTC stock could also usually be considered a penny stock.

Are Penny Stocks Worth It? Learn everything you need to know in 'Canada's Penny Stock Guide' for FREE from The Successful Investor. Canadian Penny Stock Guide: Find where to find Penny Stocks that pay well.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

Most OTC stock investments entail above-average risk—and can lead to big losses

Penny stocks are often traded “over the counter” or on the “pink sheets” (a holdover term from when over-the-counter stock quotes were printed on pink paper), which means that they are often sporadically or inactively traded through “market makers.”

If a broker is interested in buying the stock, but there are no offers to sell, the market maker will sell shares from their own firm’s account. The market maker will also buy shares if the broker wants to sell but there are no interested buyers. While the opportunities to profit from investing in over-the-counter stocks may seem extraordinary, it’s often an illusion. Bid and ask spreads set by the market makers are often very wide. A stock may have to increase 50% or more in order for you to begin to make money on your sale.

Over-the-counter stocks usually don’t have sufficient size, financial requirements or enough shareholders to meet the minimum criteria to trade on major markets. The goal of any legitimate company is to leave the OTC market as soon as possible.

Over the counter markets are generally of low quality and limited trading activity. An OTC stock rarely gets much attention from analysts or investment publications and newspapers. That adds to the difficulty of attracting a buyer for your shares at a higher price.

We’d have to see an extraordinary opportunity to recommend anything in the over-the-counter market—and nothing we have yet seen comes close.

Know the risks of the OTC market and you could keep more of your money working for you

Pink Sheets, LLC, is a private company providing pricing and financial information for the OTC securities market. Their aim is to make OTC trading more efficient and improve access to capital for OTC issuers.

Over-the-counter shares are often sporadically or inactively traded. That can make buying penny stocks and pink sheet stocks (and selling them) more difficult and expensive than shares on larger stock exchanges.

Generally, there are a very limited number of market makers for thinly traded over-the-counter stocks. This tilts the odds against you.

That’s why we’ve always stayed out of the over-the-counter market, and are likely to continue to stay out. There are just too many attractive buying opportunities in major markets where risk is lower and your chances of making money are much better.

Our investment advice: Buying pink sheet stocks can pay off extremely well when it succeeds. But, in addition to the business odds against success, it’s much easier to launch and promote a stock than it is to find a mine, for example, or invent a new battery.

That’s why pink sheet stocks are so common, even though profit-making companies are rare. It’s also why we think they should make up only a small part of your portfolio—and only be bought with money you’re willing to lose.

Use our three-part Successful Investor approach to make better stock selections

While we think it’s important for investors to know about the over-the-counter exchange, we also feel it’s far too risky for most investors to dabble in. Instead, to invest wisely, follow TSI Network’s three-part Successful Investor strategy:

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Have you ever invested in an OTC stock that became a profitable investment?

Would you recommend OTC stocks as a low-cost way to get into investing? Why or why not?