Crypto Boom, Retail Investors Fuel Rise in OTC Equity Trading

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An unusual corner of the US stock market that is home to cannabis sellers, cryptocurrency trusts and other speculative investments is seeing record levels of activity.

The volume of transactions in OTC stocks, which are not publicly traded, has exceeded $ 548 billion so far this year. This is already more than the total volume for the whole of 2020, according to OTC Markets Group,

OTCM -5.32%

the company that operates the primary market for these securities.

A major factor behind the surge is the bull market for digital currencies. The most popular OTC security this year in terms of traded value was the Grayscale Bitcoin Trust,

GBTC 4.33%

which trades under the GBTC ticker. The trust is a popular way for investors to bet on the price of bitcoin without holding actual units of the cryptocurrency.

Like the classic stock market, over-the-counter markets have seen an influx of individual investors since the start of the Covid-19 pandemic. These investors are often attracted to stocks quoted in pennies or to cheap stocks of companies too small to be listed on the stock exchange. A penny stocks forum on Reddit has 1.8 million members.

Penny stocks are risky and used to be prone to manipulation schemes. But enthusiasts say it can be profitable for investors willing to research and find opportunities in undervalued companies.

Doug Bober, a 57-year-old store manager in Los Angeles, started trading stocks two years ago to build up his retirement savings. Most of his portfolio is now in penny stocks, such as Solar Integrated Roofing Corp.

SIRC -1.85%

, a Californian company that installs solar panels on the roofs of homes and businesses.

“Of course I can play a blue chip. But if I buy a blue chip, I have to put in a lot of money and wait a long time “to get a substantial return,” Bober said. “On a dime, if you find a good, solid company, the increase is phenomenal.”

Mr Bober says his penny stock investment has paid off, but adds that risk-averse people should stay away. “It’s not much different going to Las Vegas,” he said. “You could lose a lot of money.”

Several studies have shown that investors tend to lose money on penny stocks. From July 2011 to October 2020, the average annualized return on OTC stocks of U.S. companies was -44%, according to calculations by Sihan Zhang, a doctoral student at the University of Alberta.

These numbers exclude the bulk of today’s OTC stocks: international stocks. Many foreign companies have over-the-counter U.S. stocks or certificates of deposit, including reputable companies such as Tencent Holdings. Ltd.

TCEHY -1.14%

, Nestlé HER,

NSRGY 0.59%

Nintendo Co.

and Roche Holding AG

RHHBY 1.74%

.

OTC markets are also home to the securities of some riskier foreign companies, such as indebted real estate developer China Evergrande Group and Luckin Coffee. Inc.,

LKNCY -6.41%

the Chinese coffee chain delisted from the Nasdaq last year over an accounting fraud scandal.

Foreign companies can use over-the-counter markets to gain access to US investors without having to comply with US accounting and financial reporting rules which may be redundant with the regulations of their home country. They also save money on listing fees. In total, of the approximately 11,500 securities traded over-the-counter, around three-quarters come from international companies.

“We have created a market in the United States to trade global securities,” said Cromwell Coulson, managing director of OTC Markets Group. “It is mainly international titles that drive our dollar volumes.”

If you only choose a few stocks for your entire portfolio, you are not investing, you are trading. Telis Demos from the WSJ explains the benefits of diversifying your investment portfolio. Photo: History blocks

The Securities and Exchange Commission has sought to clean up the abuse of penny stocks. Last week, an SEC rule change went into effect that largely prohibits brokerage firms from quoting over-the-counter stock prices unless the companies issuing those shares release up-to-date financial information. .

As a result of the rule change, brokerage firms such as Fidelity Investments and Charles Schwab Corp.

imposed restrictions on the purchase of these shares. Nearly 1,400 titles have been affected at Fidelity, according to a spokesperson for the company.

The SEC ruling was aimed at tackling fraudulent schemes involving the shares of companies that have become “obscure” or that have become overdue in releasing their financial statements. In some cases, these companies have effectively become empty shells whose shares have been hijacked by crooks who have attempted to manipulate the price of the shares.

Write to Alexandre Osipovich at [email protected]

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