Should You Invest In OTC Stocks?

Over-the-counter (OTC) stocks are often called penny stocks because they often have a low share price. However, just because they're cheaper doesn't necessarily mean they're a better investment.

Should you really invest in OTC stocks or are you better off putting your money toward stocks on major US exchanges like the New York Stock Exchange (NYSE) and Nasdaq Exchange?

Beware of financial reports for OTC stocks

Stocks on large exchanges have a lot more regulations and disclosure requirements than OTC stocks. This means investors trading OTC won't have access to the same transparency as investors trading major US stocks.

Other downsides to trading OTC

• Low trading volume: A lower number of traders are buying and selling OTC stocks at any given time than that of major exchanges. This increases volatility, which makes it easier for investors to lose money.

• High rate of scams: Less regulation also means more scams. Microcap stocks (aka stocks with market capitalizations under $300 million) are more likely to be subjects of fraud.

Some OTC stocks have potential

That's not to say all OTC stocks should be thrown in the trash. Cannabis stocks often list OTC because the industry is not federally legal in the US (although it's legal in many US states), meaning over-the-counter markets are a safer and simpler place to trade stock.

Legitimate startups may also trade OTC while they build up their capital and brand awareness. 

If you decide to trade in the OTC markets, make sure your broker is registered with the Securities & Exchange Commission (SEC) and licensed to do business in your state or country of residence.

The consensus: If you trade OTC, limit it to a small percentage of your portfolio

"Research shows that average yearly returns for penny stocks are roughly minus 30 percent per year." — Seeking Alpha

That's a pretty darn poor return, especially considering the entire US stock market averages about 10% positive returns annually.

If you're going to trade over-the-counter stocks, your best bet is to reserve a small percentage of your portfolio for penny stocks. This helps limit the risk you're exposing yourself to. It's a similar strategy to those who may be dipping their toes into cryptocurrency by investing just 5% of their capital in crypto.

You don't have to trade OTC to get cheap stocks

If you're after cheap stock prices, there's an alternative. Many brokerages are now offering fractional investing, meaning investors can buy a portion of a stock for as little as $1. This is an easy way to get more affordable stocks without having to take on the risk that accompanies OTC trading.

Even if you live in the Middle East, you can access fractional investing in US stocks for a flat-fee commission. As your investments grow, you'll be able to buy more and more full shares.