How to Invest in Over-the-Counter (OTC) Stocks in Share Markets: Step-by-Step Guide

Parties trade Over-the-Counter (OTC) stocks directly outside formal exchanges. This segment includes companies not listed on primary exchanges, such as emerging and smaller firms. OTC trading involves unique procedures, risks, and regulations.

Learn the meaning of OTC stocks, how OTC trading works, and the process of investing in them. This will help you make informed investment decisions and uncover hidden opportunities in less-regulated markets.

OTC stocks are securities that parties trade through decentralised dealer networks rather than centralised exchanges like NSE or BSE. These stocks belong to companies that do not meet the listing criteria or choose not to list.

OTC stocks include penny stocks and small-cap companies. These firms are typically in developmental stages or have lower trading volumes. Investors consider them for potential growth, although the market is less transparent and less liquid.

OTC Market Structure

The OTC market operates without a physical exchange. Transactions occur through a network of dealers and brokers who quote prices and negotiate trades directly. Dealers often negotiate prices in OTC trading privately, with limited public disclosure.

Globally, platforms like Pink Sheets serve as OTC marketplaces. In India, the market formalises OTC trading less, and it mainly exists for unlisted securities and some corporate bonds.

Key participants include:

• Market Makers: Dealers who provide liquidity by quoting buy and sell prices

• Brokers: Intermediaries facilitating trades between buyers and sellers

Investors: Individuals or institutions engaging in OTC transactions

It is important to understand how OTC trades work so you can make smart choices when investing. Here are the important details:

• OTC trading involves the direct negotiation of securities transactions outside formal exchanges

• Pricing in OTC trades depends on supply, demand, and dealer quotes without a centralised order book

• Investors place buy or sell orders through brokers or dealers who help find counterparties

• The process can be slower and less transparent compared to exchange trading

• Parties usually negotiate settlement timelines, which often occur within two business days after the trade date but can vary

• Brokers transfer securities to the buyer’s demat account once the settlement is complete

Over-the-Counter (OTC) stocks are those that are not listed on major exchanges like NSE or BSE and are traded directly between buyers and sellers, often via dealer networks. In India, buying OTC stocks involves more caution as these stocks are usually illiquid, less regulated, and carry higher risk. To buy them, investors can contact brokers who deal in unlisted or delisted shares. It's important to conduct thorough due diligence, verify the credibility of the intermediary, and review company financials if available. Due to the lack of transparency and limited public information, OTC stock investments are generally suited for experienced investors willing to take higher risks.

Investing in OTC stocksinvolves specific steps to navigate this unique market segment. India does not have a dedicated, functioning OTC stock exchange. SEBI de-recognised the OTC Exchange of India, launched in 1990, on March 31, 2015.

Here is the process for investing in OTC stocks:

• Open a Demat and Trading Account

A demat account is essential to hold OTC securities in electronic form. Trading requires a linked trading account with a SEBI-registered broker.

• Complete KYC Verification

You must complete Know Your Customer (KYC) formalities by submitting valid identity, address, and PAN card details. This ensures compliance and enables account activation.

• Understand the Role of Full-Service Brokers

Full-service brokers offer access to OTC stocks, along with research, portfolio management, and personalised support. They are better suited for OTC trades that need assistance and due diligence.

• Know the Limitations of Discount Brokers

Most discount brokers do not offer OTC stock trading. Even if you have an account with one, confirm whether they support such transactions before proceeding.

• Confirm Broker Access to OTC Stocks

Not all brokers deal in OTC securities, especially discount brokers. Before proceeding, check whether your selected broker supports OTC trading. Once confirmed, you can place buy or sell orders through the broker by specifying the stock, quantity, and price.

Be aware of the key risks associated with OTC stock investments:

• Illiquidity: Fewer buyers and sellers may make it hard to buy or sell quickly

• Limited Transparency:Companies may share minimal financial or operational data publicly

• Fraud Potential: Lesser regulations increase the risk of misleading or fake offerings

• Price Volatility:Small trades can trigger sharp price movement

Regulatory Gaps: Less oversight compared to exchange-listed stocks

OTC stockscome with risks, but they also offer potential advantages worth noting:

• Access to Early-Stage Companies:Potential for growth in startups or unlisted firms

• Portfolio Diversification:Exposure to assets outside mainstream markets

• Lower Entry Costs:Some OTC stocks have low share prices, enabling small investments

Niche Market Opportunities: Investment in sectors or companies unavailable on exchanges

In India, SEBI oversees overall market conduct, but OTC segments have varying oversight levels:

• Issuersmust comply with the Companies Act

• Brokers must be SEBI-registered and follow ethical trading standards

• KYC compliance is mandatory for all investors

SEBI’sonlineSCORES platform handles grievance redressal

Investing in OTC stocks requires extra diligence. Keep these in mind before you invest:

• Assess your personal risk tolerance thoroughly

• Conduct comprehensive due diligence on the companies

• Understand all cost implications, including brokerage fees

• Develop a clear exit strategy due to potential liquidity constraints

Regularly monitor investment performance and relevant market news

Managing OTC stocks effectively helps mitigate risks and capitalise on potential opportunities.

• Utilise broker platforms and alerts to track price movements

• Stay updated on company disclosures and market developments

• Maintain proper records for tax and compliance purposes

• Periodically review and adjust your portfolio as necessary

Investing in over-the-counter stocks offers unique opportunities and challenges. OTC trading operates outside traditional exchanges, providing access to unlisted companies. This can help diversify your investment options. 

OTC stocks carry risks such as low liquidity and limited transparency. These risks require careful evaluation before investing. Understanding these factors is crucial for informed decision-making.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

Securities and Exchange Board of India (SEBI): https://www.sebi.gov.in/

National Stock Exchange of India (NSE): https://www.nseindia.com/

Bombay Stock Exchange (BSE): https://www.bseindia.com/

Ministry of Corporate Affairs, Government of India: https://www.mca.gov.in/

Central Depository Services Limited (CDSL): https://www.cdslindia.com/