Many stocks that you buy are purchased through big exchanges such as the New York Stock Exchange, American Stock Exchange or Nasdaq. These exchanges usually have certain requirements for the stocks they list, but it's still possible to buy stocks that aren't listed on these systems through other quotation systems. Two of the more common ones are known as the Over the Counter Bulletin Board (OTCBB) and the Pink Sheet stocks system. The two are similar, but OTCBB is operated by the finance world's self-regulatory authority and has slightly more stringent requirements, while the modern Pink system is a bit looser about what stocks can be traded.
Although both the pink sheets and the OTCBB allow investors to purchase stocks that aren't listed on major indexes, the pink sheets are significantly less regulated than the OTC Bulletin Board.
OTC and Pink Sheets
If you hear someone talking about OTC stocks, that refers to stocks traded over the counter, meaning they're not bought and sold through a traditional exchange. OTC can also refer to the OTC Bulletin Board, a system for sharing information in real time about prices and purchases of OTC stocks. In many cases, that's what your broker will use to help you buy and sell OTC stocks.
Historically, prices for stocks listed on exchanges were only available once per day, due to the lack of trading volume in many such stocks. Those prices were distributed on pink pieces of paper, often called Pink Sheets, and those stocks came to be known as Pink Sheet stocks.
Today, Pink Sheets can also refer to the Pink service of a company called OTC Markets. It's a platform for brokers buying and selling stocks not listed on the traditional markets. Companies listed on Pink are permitted to provide investors with very limited information about their finances, assets and operations.
Some brokers may charge more to buy and sell on the OTC markets, and it can be difficult to quickly buy or sell stock for the price you want, since the number of buyers and sellers on the other side of your transaction is often quite limited. Consult with your brokerage if you have any questions about the procedures for dealing in such stocks and whether you'll face an unexpectedly high commission should you do so.
Comparing OTCBB and Pink
The OTCBB system is operated by the Financial Industry Regulatory Authority, which is a nonprofit group that sets standards for the securities industry. Stocks with quotes on OTCBB must generally be registered with the Securities and Exchange Commission, except for certain types of companies such as banks and insurers that legally are exempt from doing so. If a company doesn't make required filings, OTCBB will stop listing it.
Pink generally has less stringent requirements, and companies listed on Pink may be unregistered with the SEC and may not always file regular reports. Some stocks on Pink may not be eligible for listing on OTCBB for that reason. Some stocks are listed on both OTCBB and Pink.
Other OTC quotation services exist, and it's also possible to buy stocks that aren't quoted on either system by making arrangement with a broker. These stocks may be harder to buy or sell quickly due to limited activity in the market.
If a stock appears to be only quoted on Pink or not on any public quotation service because it isn't meeting regulatory requirements, that should usually be taken as a red flag.
How Stocks Work
Shares of stock in a company represent an ownership stake in the company.
Investors typically buy stocks hoping that the company will grow in value and that they will be able to sell the stock at a higher price later on. You can also make money if the company issues a dividend, paying a share of its profits to investors in proportion to how much stock they own, or buys back stock, trading cash for shares of its own stock.
Stock trades are generally regulated by the Securities and Exchange Commission and similar regulators in other countries. Some are also regulated by state authorities. Companies generally are required to file paperwork explaining both how their stock works in terms of the number of outstanding shares and the rights they confer, as well as the basics of how the business is doing, such as the company's income and cash on hand. These filings are usually available through the company, through brokerage websites or through the SEC and can be valuable information when you're deciding whether to buy or sell a stock.
Buying and Selling Stock
In some cases, you can buy stock directly from the company that issues it, but it's much more common to buy through a stock brokerage. Most modern brokerages allow you to buy, sell and manage your stock online.
To buy or sell stock, you will generally search for how much the stock is currently trading for and instruct your broker on how many shares you wish to buy or sell. Most brokers will charge a commission for each transaction, though exactly how commissions work varies from broker to broker. Shop around for a broker with a commission structure you want.
OTC and Penny Stocks
Many of the stocks listed on the OTC markets are what are known as penny stocks. These stocks usually cost more than a literal cent per share, but they are still quite inexpensive. Usually, the term is used today to mean a stock offered for sale for less than $5 per share. Usually, the market capitalization, or total stock value, of the companies is also low.
Penny stocks can be lucrative for lucky or savvy investors, because the small number of shares in play and small cost to purchase can lead to rapid price gains. Penny stock purchasers can also make money in the long term if the company grows and its stock price leaves penny territory.
Still, penny stocks can also be riskier than other investments. Many penny stock companies are either quite new, with their performance relatively untested, or they're struggling companies at risk of bankruptcy. It's possible for investors to quickly lose their investments in penny stocks. Some investors choose to set stop-loss orders with their brokers to automatically sell their holdings if the stock price drops below a certain minimum threshold or set orders to sell if they gain a certain amount.
If you're considering buying an inexpensive stock, make sure you consider more than the low price. Study whatever information is available from the company issuing the stock and from trustworthy third-party analysis and news services. Keep in mind that it may be difficult to quickly exit positions in penny stocks if prices begin to dive, since there is often a limited market for the shares.
Penny Stock Scams and Fraud
Penny stocks have often been associated with fraud, perpetrated either by the company issuing the stock or unscrupulous investors.
Often, fraudulent investors will run what are called pump-and-dump stock scams, enticing other investors to buy the stock based on false information. They'll usually purchase the stock, then promote or "pump" it through posts on online forums or mailing lists, newsletters that don't disclose their conflict of interest or telemarketing calls. Once other investors buy in, the fraudsters sell, or "dump," their shares at a profit. Since the inflated stock price was chiefly based on the fraud, other investors will lose out if they don't quickly sell themselves.
Since penny stocks and other OTC stocks often disclose less information than other securities, business owners and insiders can also manipulate markets by lying about company performance, fraudulently raising money for themselves.
In general, be wary of stock tips from sources you haven't confirmed are independent and trustworthy, especially when it comes to penny stocks. Search for independent information and do your own research before making any investments.
Stocks and Your Taxes
Generally, if you hold on to a stock or other investment for a year or longer, then sell it for a profit, you can pay federal income tax at the long-term capital gains rate. This rate is 15 percent for most investors and is often less than your ordinary income tax rate, which you'll pay on income from work and shorter-term investments. Some investors pay 0 percent or 20 percent on long-term capital gains.
If you plan to hold on to OTC stock for only a short-term gain, you won't see this tax benefit. Consider tax ramifications as one of the factors influencing your investment decisions.
Video of the Day
- Investopedia: Pink Sheets
- Investopedia: What Does It Mean When a Stock Trades on the Pink Sheets or the OTCBB?
- Investopedia: Over-The-Counter Bulletin Board - OTCBB
- OTC Markets: Choosing the Right Market for Your Company
- FINRA: OTC Bulletin Board (OTCBB)
- OTC Markets: Information for Pink Companies
- Fidelity: Trading Penny Stocks Can Be a Big Risk
- Penny Stocks: 5 Ways to Spot a Pump-and-Dump Scam
- IRS: Topic Number 409 - Capital Gains and Losses
- FINRA: OTCBB Frequently Asked Questions
- Investopedia: Introducing Pink Sheets: The OTC market
- FINRA: About Finra
- Extraordinary Investor: Grey Sheets Trading Should be Avoided