Topic: Penny Stocks

What are pink sheet stocks?


Pink sheet stocks are the Wild West of U.S.-based stocks and for investors looking for high-risk investments.

Companies that trade on the U.S. over-the-counter market are said to trade as “pink sheet stocks,” a holdover from the days when the quotes for these stocks were printed on pink paper.

Today, Pink Sheets LLC, a private company, is the main provider of pricing and financial information for the over-the-counter (OTC) securities markets.

Pink Sheets’ centralized information network includes services for issuers, brokers and OTC investors, as well as “market makers” (more on them below). Pink Sheets’ information aims to make OTC trading more efficient and improve access to capital for OTC issuers.

Companies that trade “pink sheets stocks” usually don’t have sufficient market caps, or enough shareholders, to meet most stock exchanges’ minimum criteria.

Over-the-counter shares are often sporadically or inactively traded. That can make buying penny stocks and pink sheet stocks (and selling them) more difficult and expensive than shares on larger stock exchanges.

As well, over-the-counter stocks trade through “market makers,” or traders who maintain an orderly market in a particular stock by standing ready to buy or sell shares. The market maker’s job is to maintain a firm bid and ask price for their assigned securities. If a broker wants to buy a stock, but there are no offers to sell it, the market maker fills the order by selling shares from their own firm’s account. If a broker wants to sell, but no one wants to buy, the market maker buys the shares.

Generally, there are a very limited number of market makers for thinly traded over-the-counter stocks. Bid and ask spreads, set by the market makers, are sometimes so wide that if you buy a stock, it may have to go up 50% or more before you’ll even begin to make money on a sale.

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Over-the-counter stocks may at times seem to offer extraordinary opportunities, but this can be an expensive illusion. Most legitimate companies with substantial growth potential will want to leave the over-the-counter market as quickly as possible, and move to the major markets. This tilts the odds against you.

That’s why we’ve always stayed out of the over-the-counter market, and are likely to continue to stay out. There are just too many attractive buying opportunities in major markets where risk is lower and your chances of making money are much better.

Our investment advice: Buying pink sheet stocks can pay off extremely well when it succeeds. But, in addition to the business odds against success, it’s much easier to launch and promote a stock than it is to find a mine, for example, or invent a new battery.

That’s why pink sheet stocks are so common, even though profit-making companies are rare. It’s also why we think they should make up only a small part of your portfolio—and only be bought with money you’re willing to lose.

Stocks go up and down every day. Sometimes there is an obvious cause in good or bad news. But there’s a large random element to stock price changes, particularly over short periods.

Here are two of the most common investment errors:

  1. Becoming more “bullish” or optimistic because stock prices have gone up. Some investors only feel safe buying stocks or mutual funds after prices have risen. This is opposite to the way you make most purchases (cars, clothing, etc.) Ordinarily, it’s better to buy when prices go down, not up.
  2. Becoming more “bearish” or pessimistic because stock prices have gone down. When other investors sell and drive prices down, you may wonder if they know something you don’t. However, random influences may be at work.

Learn all you can about your investments. Read the quarterly and annual reports of companies, ETFs or mutual funds you invest in. Even for pink sheet stocks!

What’s your take on pink sheet stocks? Do the rewards outweigh the risks? Let us know in the comments.

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