By definition over the counter stocks are stocks that are traded through broker dealers not through centralized stock exchanges. Simply all stocks which are traded outside major stock exchanges like Nasdaq and NYSE are considered as Over-The-Counter (OTC) stocks.
Attention that although Nasdaq work as a system of broker dealers connected with a central computer it’s not considered as an over-the-counter market, albeit some claim so. the 2 majors over the counter stock trading markets are Over the Counter Bulletin Board (OTCBB) and Pink Sheet.
The companies, of which stocks are traded OTC, could also be new companies, small/growing companies unable to satisfy minimum requirements of major stock markets or companies delisted from major stock markets (also referred to as unlisted).
The stocks from these companies are usually referred to as penny stocks or as micro-cap stocks. Remember that over-the-counter market also trades government & municipal securities, corporate bonds, asset-backed securities and mortgage backed securities.
As said earlier, over the counter stock trades are done via direct interactions between brokers and market makers either through phone or network. The market makers are the holders of OTC stocks, who on demand sell them to the brokers.
The worth of the stocks is determined by negotiation between the market maker and broker through a process of ask and bid, not as auction bidding as within the stock market floor. So, a trader wants to trade OTC stocks must first open a trading account from one broker, either discount or full service, offering OTC trading service.
Then he/she can place her order through the broker. Today there also are some online stock brokers who allow traders to interact directly with the market makers.
OTCBB and Pink Sheet market differs in their listing requirements. OTCBB market demands some minimum requirements from companies to list and remain within the market. These requirements are somewhat easier to take care of than the NYSE requirements.
On the opposite hand Pink Sheet market doesn’t need any minimum requirements to be listed. This easy in listing makes both of those markets susceptible to trade. the businesses listed might not have proper financial background and history; actually, many companies delisted from major exchanges are often on the verge of bankruptcy.
OTC stock trades involve more the prospect of loss than profit. it’s a market known for frauds and for its volatility. Some problems that OTC markets have involves no/easy minimum requirements making bad companies to be listed, serious lack of company information like financial history & present status.
Low liquidity making selling of purchased securities difficult, price manipulation on certain stocks by brokers, and cheating advertisements through all kinds of media highlighting false advantages of company/broker/market.
Even though with of these demerits, over the counter stock trading is increasing its popularity. The new advancements in information technology and tracking methods improved availability of company and market information.
Also, variety of companies listed in these markets are growing speedily to form their way into large stock exchanges. On a recent trend, many companies qualified from OTCBB for giant markets have chosen to stay in over the counter trading, as they believe is that the perfect trading method for them.
This increased the reliability of the market. the principles enforced by National Association of Securities Dealers (NASD) also contributed thereon.