The over-the-counter (OTC) market is the wild west of the stock market — filled with risky penny stocks, less regulations and potential fraud.

During COVID, trading in OTC stocks surged — driven by individual investors craving more risk, who bought Hertz (OTC:HTZZ) when it was near bankruptcy or in the Grayscale Bitcoin Trust (OTC:GBTC), a popular method to gain exposure to Bitcoin.

Companies trade over the counter if they fail to meet requirements or cannot pay the high costs to list on major exchanges like the NYSE or NASDAQ.

• You’ll know if a company is trading on the OTC market if the exchange says OTC instead of NASDAQ or NYSE.
• Many investment platforms in the US (i.e. Public and Robinhood) won’t give investors the option to trade OTC securities.

Where it gets risky: Stocks trading on the OTC market are riskier due to:

• Higher risk of fraud — OTC companies are required to report less and often have a lack of or outdated information/financials.
• Less liquidity — Less buyers/sellers can lead to unfavorable prices when buying or selling an OTC security.

According to a past study from the University of Alberta, between July 2011 and Oct 2020, the average annualized returns of US OTC stocks was -44% — i.e. the average investor would have lost nearly half their money each year.

But not all OTC securities are so risky. The -44% excludes international companies like Tencent, Nintendo and Nestlé — which make up the majority of OTC companies.

Regulating the West: Last week, the securities and exchange commission enforced a rule to prevent investors from buying stocks with outdated financial reporting — making it harder to run pump and dump schemes.