Editor’s note: This article was first published in December 2012. The typical share prices, the roughly 100 euro commission per trade from Spain and the reference to the MAB (since renamed BME Growth) reflect that time; OTC Markets has also changed its tiers and disclosure rules since.
You’ve probably heard that some investor made 100,000 euros out of just 1,000 euros in a single day. That’s a 10,000% gain. On the OTC Pink market it’s possible. You’ve probably also heard of people who lost everything on the stock market overnight. On the OTC market that’s very possible too. What is the OTC market, how does it work and what are its risks?
OTC markets are unorganised markets not regulated by the SEC, the US equivalent of the CNMV in Spain (the National Securities Market Commission), although in fact currency trading also takes place on an unorganised market. The companies listed on this market (Pink) have a very small market capitalisation, and their share price is usually below 0.50 dollars. They are companies that don’t meet the requirements to list on the “first division” exchanges. It’s very common to find shares priced at 0.0002 or 0.0012. Companies we’ve mentioned in a previous article, such as Cannabis Science, trade on this market.
A simple way to sum it up would be to say that this market is a breeding ground for companies. Many of them will end up playing in the first division and others will close down, while others are expelled from other markets and end up languishing on this one for years. That’s why you need to analyse the company to get the investment right.
The company that regulates this market is OTC Markets Group Inc., formerly known as Pink OTC Markets Inc. It provides an electronic quotation system that displays brokers’ quotes because, on this market, although anyone can invest, prices are negotiated between brokers.
OTC Markets Group Inc. is not registered with the SEC and is not a Financial Industry Regulatory Authority. Companies listed on these markets are not required to file their financial statements with the SEC, so you sometimes run the risk of buying on the back of news released by the companies themselves that turns out not to be true. At other times, because of these companies’ small market capitalisation, a larger company may buy the whole business, and in that case the stock can rise by as much as 20,000%, as happened with Gateway Industries, a company that went from 0.03 dollars to 3 dollars in a single session. Anyone who had 1,000 euros invested made 200,000 euros in a single session.
So, to sum up: the OTC market ranks below the MAB (Mercado Alternativo Bursátil, Spain’s alternative stock market for small growth companies), and its companies don’t even reach the category of penny stocks, but… some of them will at some point move up to the first division or be bought by industry giants.
An example of a deal on this market: a newly founded pharmaceutical company needs financing to develop a new drug, so it turns to this market. If the trial ends in failure, the investor can lose everything, and if the drug lives up to expectations, the investor strikes it rich. That’s why on this market there is sometimes no middle ground: either you make a huge amount of money or you lose your entire investment. Heads or tails.
People sometimes joke that if you go overboard buying shares in these companies, one day you might get a call telling you that you now own the company.
In my latest purchase on this market I bought 300,000 shares of Herborium Group for around 700 euros. One drawback of this market, at least from Spain, is that the commission is around 100 euros when you buy and another 100 euros when you sell.
Clearly, you have to enter this market with a long-term mindset and be a very aggressive investor, because speculation is the order of the day.
Featured image: George U. Young, Derby Mining Company, Public domain, via Wikimedia Commons.
