What Is the Definition of OTC in the Stock Market?
The over the counter (OTC) market is used for the sale of stocks, bonds, commodities and derivatives that may or may not be listed on major exchanges. The OTC market does not have a central meeting place like an exchange. Rather, it uses people called market makers who are collecting points for stocks who then deal with one another, usually over the computer or phone, to trade the stock, bond or other commodity.
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Funtion of the OTC markets
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OTC markets are often used by companies that are not listed on major stock exchanges. A company might not be on a stock exchange if it is too small or if it is in the bankruptcy process. The OTC market creates bilateral transactions directly between the buyer and the seller.
Examples of OTC markets
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The most common OTC markets are called the Pink Sheets and the OTC Bulletin Board. Of these two, the Pink Sheets are much more commonly used. The Pink Sheets include many "penny stocks" but also includes some more famous companies, such as Nestle, who do not want to be subject to the regulations associated with trading on a stock exchange.
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SEC Reporting
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Not all OTC stocks are required to report to the Securities Exchange Commission (SEC). In fact, stocks on the Pink Sheets are not required to meet the minimum financial disclosure requirements of the SEC. Consequently, there is a risk that the financials of these companies will not be as accurate or detailed as those of a company traded on a stock exchange.
Scams with OTC stocks
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Spammers often send emails encouraging investment in a certain OTC stock as part of a "pump and dump" scam. Pump and dump scams begin with the scammer buying stock in the OTC stock at a low price. Then the scammer will spread emails about the merits of the stock to drive up its value. Once the price of the stock has gone up, the scammer sells his shares and the stock price drops. OTC stocks are especially vulnerable to this because they tend to have smaller trading volumes, which makes price manipulation more easily achieved.
Potential investment in OTC stocks
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Before investing in any stock, it is important to conduct research on the company and its merits. This is especially true for OTC stocks. Some OTC stocks do produce financial reports that are subject to regulatory requirements and which have been properly audited, while others do not. Because of the challenges presented by this inconsistency in reporting, it may be useful to consult a financial adviser before making any such investment. At a minimum, it is important to learn as much as possible about the legitimacy and viability of the company as possible.
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