Penny stocks are relatively popular stocks among day traders in the United States. These stocks mostly refer to companies whose share prices trade for less than $5. Many of them are listed in leading exchanges like the New York Stock Exchange (NYSE) and Nasdaq.
Other types of penny stocks are mostly traded in the over-the-counter markets. Some of these are known as pink sheets. This report will look at what pink sheet stocks are and how to trade them.
What are pink sheet stocks?
Pink sheets are stocks of companies that are provided in the over-the-counter (OTC) market. These services are provided by a company known as OTC Markets, which is a publicly traded company that is valued at more than $495 million.
They are known as pink sheets (or OTC Pink) because in the past, the stock names were written in a pink paper. Today, this trading has gone electronic.
In most cases, pink sheet stocks are relatively small companies that don’t meet the listing requirements require by large bourses like the NYSE.
However, at times, some big foreign companies opt to list using pink sheets because they don’t want to go through the long IPO process. They also don’t want to deal with the vast SEC disclosures.
Pink sheets differ from companies listed in major exchanges in several ways. For one, they are not required to publish their quarterly results and other documents. These firms list when they meet the conditions set by OTC Markets.
In fact, OTC has three tiers for pink sheets, including those that provide no information, limited information, and current information.
Since most of them are not followed by many Wall Street analysts, there is usually limited information available. For example, there are no earnings calls and no analyst calls on these firms.
Pink sheets vs OTC stocks
There is a relatively small difference between pink sheet stocks and OTC stocks. OTC stocks are companies that trade in the over-the-counter. Some of these stocks have high standards. According to OTC Markets, there are more than 12,000 securities that trade in the over-the-counter market.
On the other hand, pink sheets (remember, also known as OTC Pink) have the lowest standards of all firms listed in the OTC markets. For example, they only need to submit two annual reports, an attorney letter covering all relevant information, and a company profile.
Examples of these stocks
There are many pink sheet stocks available to trade today. Most of these are relatively small companies that have limited business exposure. Unlike big companies, many of them don’t publish their form 10k, which is the annual report.
At the same time, many large foreign companies are also traded in the pink sheet market. Some of the biggest pink sheet stocks are:
- Tencent Holdings (TCEHY) - This is the biggest tech firm in the world. It owns popular brands like WeChat and Call of Duty.
- Excellerant Inc (EXCL) - This firm provides health information and travel services.
- Philips Edison (PHCED) - It is a real estate trust company that owns and operates several shopping centers in the US.
How pink sheet stocks work
To start with, you need to know how companies go public in the United States. Basically, there are several ways that this happen.
Some companies like Spotify and Palantir opts to go public through direct listing in major exchanges like Nasdaq and the New York Stock Exchange (NYSE). In direct listing, the firms sell their shares directly to investors. It is often seen as a cost-effective option for companies to go public.
Second, most companies go public through an Initial Public Offering (IPO). This is where a company raises money from investors and goes public. Most companies like Uber, Facebook, and Apple went public through an initial public offering.
Third, many companies are opting to go public by merging with shell companies in a process known as SPAC listing. Many companies like Nikola and Virgin Galactic went public through this method.
»What is a Reverse Merger (and differences with an IPO)«
Now, the common denominator is that these processes are always long and expensive. They also require that firms submit a lot of documents to the Securities and Exchange Commission (SEC). Therefore, many small companies prefer going public through the open market. This category also includes many large foreign companies that don’t want to disclose a lot of details to the SEC.
They partner with OTC Markets, which is a company that offers these services. If they meet the basic criteria for listing, the firm shares become publicly traded in the OTC market as pink sheets. After being listed, the stocks can be traded by many traders.
How to day trade pink sheet stocks
Like mentioned above, most pink sheet stocks are small companies with limited information. Therefore, it is wise that you day trade them instead of investing in them for the long term. Also, unlike large-cap stocks like Facebook and Uber, these companies tend to be thinly traded because they are mostly held by traders.
Therefore, they tend to have a lot of volatility.
To trade pink sheets, you first need to find a broker that accepts them. Many American brokers like E*Trade and TD Ameritrade have partnered with OTC Markets to offer these shares. These companies act as an agent.
After finding a broker, you need to find more about the companies. Finally, you should do both technical and fundamental analysis to find market opportunities. After opening a trade, you should ensure that you close it by the end of the day (to avoid overnight positions).
Pros and cons of trading pink sheet stocks
There are several benefits and disadvantages of trading pink sheet stocks. First, it exposes you to companies that are not traded by most people. Second, pink sheet stocks provide you with opportunities to trade low priced stocks. Finally, they are often high volatile stocks that can lead to more opportunities.
The main disadvantages of pink sheet stocks are that they are prone to pump and dump schemes. They are also high risk stocks because of limited disclosures. Also, they tend to have low liquidity (and liquidity is very important in the markets).
Summary: who should trade them?
Pink sheet stocks are popular among some day traders (experienced one). Still, the equities tend to be high risk, volatile, and have low liquidity. In this article, we have looked at how they work and some strategies to day trade them.
External Useful Resources
- Using Caution When Trading Pink Sheets Stocks - Investopedia
- Newbies Discover Penny Stocks and 1 Trillion Shares Get Traded - Bloomberg