A liquid stock with many buyers and sellers is best because the market can set a fair value. But when a stock only trades a few thousand shares a day, it is more likely that wild price swings can happen based on just a modest amount of activity.
Also, OTC stocks reside on the pink sheets for a reason sometimes. They do not meet minimum requirements of major exchanges in regards to both logistics of trading, like a minimum share price, and in regards to financial reporting. Pink sheets do not have to file with the SEC, so it’s tough for investors to get all the facts. In addition to not knowing the fundamentals of an investment, a lack of reliable information makes it easy for investors to be seduced by scam artists.
How to Make OTC Stocks Work for You
Still not sure if pink sheet stocks or OTC investments are good for you? Well, just follow these three tips to protect yourself:
- ALWAYS Use a Limit Order: Never place a “market order” for stocks, meaning you are letting the market dictate a price for you. If a stock is priced at $10 right now, place your “limit” at $10.25 or $10.50 and see if your order gets filled. You might not always get into the stocks at the price you want, but it’s better to err on the side of pricing controls than to just tell your brokerage software to buy a stock at whatever price it feels like. You could wind up spending a boatload more than you planned on that initial buy-in.
- Demand Numbers: Just because the SEC isn’t breathing down the necks of OTC stocks doesn’t mean pink sheet investments have no paper trail. ADRs like Sony (NYSE:SNE) and Toyota (NYSE:TM) are very forthcoming with their records of sales and profits. Some smaller companies are, too. Make sure you do your due diligence first — and if a company can’t provide all of the relevant information, don’t chase it.
- Build a Diversified Portfolio: Pink sheet stocks, particularly penny stocks, can be enticing because of the high profit potential. But don’t fool yourself into thinking that you can build a stable portfolio with pink sheets alone. These investments should be used sparingly as part of a broader, diversified portfolio — or else you could really get burned.
Jeff Reeves is the editor of InvestorPlace.com. Write him at firstname.lastname@example.org, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.