Looking to buy over-the-counter (OTC) stocks?
It can be quite confusing, and not always as simple as clicking a button. I’ve come up with a somewhat simple procedure to buy OTC stocks in Canada.
Below are the steps for including over-the-counter stocks in your personal portfolio:
- Determine that the OTC stock you are looking to purchase is appropriate for you.
- Open the appropriate account with a brokerage that allows the trading of OTC securities.
- Place the order for the OTC stock, either through the brokerage’s online platform or over the phone.
- Consistently monitor your OTC stock position(s) to make sure that they are still aligned with your investment objectives and overall goals.
How do OTC Stocks Work?
Here’s the difference between listed stocks and OTC stocks.
Listed Stocks – Where Most Popular Stocks are Found
Regardless of the stock, chances are fairly high that it would be considered a publicly listed company.
The total value of a publicly-traded company is usually above a specific amount, and the shares of said company trade freely and efficiently on one or more of a country’s exchanges.
In Canada, more information on the listing requirements for the Toronto Stock Exchange or the TSX Venture Exchange can be found here. Examples of stock exchanges in the US include the NASDAQ and the NYSE.
Stocks that are Unlisted are Traded “Over-the-Counter”
If you are considering investing in stocks, it’s important to understand that there are quite a number of opportunities that will not show up on a traditional exchange, which you may want to consider.
These equities are considered over-the-counter (OTC) stocks and are traded very differently than their publicly traded counterparts.
Since OTC stocks are not listed on an exchange where buyers and sellers of the stock are paired together for efficient trading, they are usually bought out of a firm’s inventory (called a market maker), through your brokerage.
Purchasing OTC stocks can carry additional costs and risks, which are outlined further on.
Steps to buy OTC Stocks
Step 1 – Deciding that a Specific Stock is Appropriate for you
Whether you are purchasing listed or OTC stocks, the first step is always to determine whether an investment makes sense for your particular circumstances.
Some crucial things to consider before continuing purchasing any stock include, but are not limited to:
- How willing and able are you to take risk?
- When is the earliest you would sell your stock position?
- What are the specific risks involved with the company?
- Is your return potential attractive and are there better opportunities available?
- Is the company involved in anything that goes against your personal beliefs?
On a risk scale from low to high, a stock investment in any company is usually rated at least medium risk with most brokerages in Canada.
If a stock is traded OTC, it could be because the company is too small to be listed on a major exchange.
OTC stocks also have different reporting requirements, and usually offer less transparency into their operations, which make them higher risk investments (and prevent them from being listed).
When purchasing an OTC stock, also consider the following additional points:
- Are you willing and able to accept a high level of risk?
- What are the additional broker-specific fees involved with trading OTC stocks?
- Are you willing to accept a wider bid-ask spread than those of most listed stocks?
- Are you willing to own a (generally) highly illiquid stock holding?
The following video does a great job of explaining some of the additional intricacies of investing in OTC stocks:
Once you have thoroughly determined that the OTC stock you would like to purchase is appropriate for you, it’s time to consider your choice of brokerage and account.
Step 2 – Selecting a Brokerage and Opening a Non-registered Account
Now that you have decided to purchase an OTC stock, you will need to use a broker that allows the buying and selling of over-the-counter stocks.
Discount broker capabilities are constantly changing, but some main ones to consider for OTC stock purchases currently include:
Other discount brokerages may be able to accommodate OTC stock trading, but always make sure to check by reading their website or calling in to inquire.
The choice of account to hold your OTC stock is fairly limited in Canada – it will have to be in a cash or margin non-registered account. The differences between cash and margin accounts are explained in more detail here.
Over-the-counter stocks are not allowed within registered accounts such as a TFSA or RRSP since they are considered non-qualifying investments.
Once your account is set up at a brokerage that can handle OTC stock trades, you are ready to plan and place your trade.
Step 3 – Placing your OTC Stock Trade
Most information that you will need to place your OTC stock trade will likely be found on the OTC Markets Group’s website.
This will be an important reference point for price and liquidity for a large number of OTC investments, including OTC stocks.
You will want to use the website as a main reference point for a few key pieces of information, such as the stock’s ticker and bid-ask spread.
Finding your OTC Stock Ticker
Based on the OTC stock you would like to purchase, it will fall into one of three categories with the OTC Markets Group:
Group 1: OTCQX (also known as OTCQX Best Market), which include “companies [that] meet high financial standards, follow best practice corporate governance, demonstrate compliance with U.S. securities laws, and have a professional third-party sponsor introduction.” The ticker convention here is (OTCQX: AAAA).
Group 2: OTCQB (also known as OTCQB Venture Market), which include “early stage and developing U.S. and international companies. Companies are current in their reporting and undergo an annual verification and management certification process.” The ticker convention here is (OTCQB: AAAA).
Group 3: Pink Open Market, which includes all other stocks. The ticker convention here is (PINK: AAAA).
Once you have found your stock ticker, it’s time to plan how you will place your trade.
Planning your Trade
How you would like to have your trades executed can have a large impact on the return you will get from your investments.
Since one of the big drawbacks of OTC stocks is their illiquidity and large bid-ask spreads, an easy mistake to make is to rush and place a market order for the amount you would like to purchase.
For OTC stocks (and illiquid investments in general), a good approach to follow is to place a limit order around your desired purchase price.
While you are not guaranteed to have your full stock order filled at your limit price, the main benefit of this type of stock order is that you will not purchase any stock at radically different values.
Once you have found your OTC stock’s ticker, and have planned your trade appropriately, the trade can usually be placed through your brokerage’s online platform, or over the phone.
Step 4 – Monitoring your OTC Positions
Now that one or more OTC stocks are part of your portfolio, it is important to periodically review your positions.
It’s reasonable to expect large price movements in these companies, especially over larger periods of time, due to their riskiness.
As time passes, consider that:
- The value of your high-risk OTC stock could go to zero.
- Your initial OTC stock holding may begin trading on an exchange through a process known as listing, due to meeting listing requirements.
- The liquidity of your position could change over time, due to increases or decreases in supply or demand for shares.
A good rule of thumb is to review your portfolio at least quarterly, to make sure that your current investments are still aligned with your goals and objectives.
Bringing it all Together
Once you have decided to include OTC stocks in your personal portfolio, remember to follow the above four steps.
Make sure that the stock you would like to purchase is appropriate for your specific situation, and that you have a non-registered margin or cash account with a broker that can accommodate OTC trading.
Plan the purchase of your OTC stock ahead of time, and look to incorporate limit orders as much as possible to avoid purchasing your stock at radically different prices.
Lastly, monitor your holdings over time for any significant events, such as a potential exchange listing or changes in your stock’s liquidity.
Although OTC stocks are generally considered high risk, they can lead to substantial gains if incorporated correctly. Aside from a lot of research, make sure that any OTC stocks fit your specific investment criteria.
Remember to also incorporate listed equities into your portfolio as well, with various sector ideas available here.
Just because an OTC stock is not part of a major exchange, it does not necessarily mean that it can’t become a wildly successful company in the future.