Diving Into The OTC Market Of Penny Stocks
What are penny stocks?
Penny stocks are stocks which trades at a low price and have small market capitalization. Also commonly known as OTC stocks, they are traded over the counter and not listed on the major stock exchanges. Instead, they are listed on the Over The Counter Bulletin Board (OTCBB).
Penny stocks are listed on the OTCBB due to one of the following reasons:
1) The company has already been delisted from any major stock exchange. As the company fails to meet the requirements (usually nearing bankruptcy or financial difficulty) to be listed on the stock exchange, it will be delisted.
2) The company may already be listed on OTCBB as it could not meet the initial listing requirements of the major stock exchanges. During which, the company can test if there is a demand for their shares before diving into larger stock exchanges.
How does the penny stock prices move?
Similar to the stock prices listed on the major exchanges, the price of the penny stock will be recorded as the price of the latest transaction. Whereas for bid price, it will display the highest price in order to buy that stock (the amount you have to bid for the stock). As for ask price, it is the lowest price that a seller can ask for to sell the stock.
What are the advantages and disadvantages of trading penny stocks?
They are cheap to buy, with some even less than $1. A tiny price movement in the stock would result in great returns.
If you are purchasing the stock which is growing financially but has not fulfilled the requirement of being listed on stock exchanges yet, you might be in on a rising stock and might end up on the major exchange in the future.
On the flip side, higher returns would come with higher risks. Due to the high volatility levels, you might end up losing a whole lot. With these OTC stocks being thinly traded, you might not be able to exit your position and cash out in time as the volume is relatively low.
Moreover, as OTC stocks need not report any information to investors, there is limited financial information to go around to know what you are actually buying and know the financial health of the company at that point in time.
What are the things to look out for to trade penny stocks?
- Financial health of company
Although penny stocks do not usually release detailed financial information, it will certainly require some due diligence on your part to check the financial health of the company. Scrutinize the amount of debt, cash on hand and liabilities outstanding to see if the company is coping well. Also, if the income statement shows increasing revenue growth, it is one promising sign that it might be a good penny stock.
2. Quality of disclosure
The quality of disclosure also plays a part. The more information the company provides, the better it is as it shows high levels of corporate transparency. The OTC Markets Group segments the securities into 3 tiers: OTC Pink, OTCQB (mid tier) and OTCQX (top tier) based on the quality of disclosure, the investor’s engagement and the integrity of the company’s operation. Also, with the tiers label, you should be able to gauge the level of risks associated with each tier.
3. Future growth and plans
You should also analyze if the company’s business plan is achievable based on their information released and the market conditions or economy.
The bottom line is that penny stocks are like going to the casino to gamble. Despite the huge potential gains, it might be more profitable by investing in proven companies with track records. Unless you are in for the high risk high return, go for the long term investments like REITs, ETFs or blue chips instead.