Going Global: Trading Foreign Stocks OTC

Key Points

  • Trading foreign stocks over-the-counter is an increasingly popular way to add international investments to your portfolio. 
  • We'll examine how this market works, its benefits and drawbacks, and how to get started.

Looking to invest in foreign stocks? If so, you're not alone. International investing is becoming more mainstream. As we've discussed previously, investors have come to realize its benefits, including the potential for higher rates of growth and the potential for reducing the risk of your overall portfolio through diversification.

Although ADRs, ETFs and mutual funds all provide ways to add an international flavor to your portfolio, trading international stocks (also known as "ordinaries") online through the U.S. over-the-counter (OTC) market has become increasingly popular in recent years.

Thanks to improved technology and greater ease of listing foreign stocks, the OTC market has expanded significantly. It offers a lot of well-known, large-cap stocks, including Toyota and Deutsche Telekom.

Here, we'll take a look at:

  • How the OTC market works
  • Its benefits and drawbacks
  • How to get started

How does the OTC market work?

The OTC market is a computer- and telephone-based system. Any stock that does not trade on NASDAQ or a national securities exchange like the New York Stock Exchange can trade over-the-counter. Stocks that trade over-the-counter are also known as "unlisted stocks."

A number of competing broker-dealers, also called market makers, negotiate directly with each other to price OTC stocks. Market makers earn money via the bid/ask "spread"—buying the stock for less than they sell it, and selling the stock for more than they buy it.

Because of the complex reporting requirements and expense of listing on registered exchanges, the OTC market has become an attractive platform for international companies to offer their securities in the United States.

OTC trading occurs only during U.S. market hours. If you make a trade, you are buying or selling the actual foreign ordinary shares. The value of these stocks rises and falls based on the price of the company's shares traded in their home country. While the value of the foreign ordinary share and the company's share in the home country tend to be close, there can be pricing discrepancies, which we'll discuss in a moment.

Trades, although reported in U.S. dollars, include the potential gain or loss from exposure to foreign currency fluctuations. This is an important point because changes in the value of the underlying currency in which your stock is held can impact your investment returns.

What are the benefits of trading foreign ordinaries OTC?

A large number of stocks: This marketplace has grown enormously in recent years. In 2003, only 1,500 foreign stocks traded in the U.S. OTC market; as of November 2013, that number was close to 3,600, according to Interactive Data Corporation via FactSet Research Systems.

Access to multinationals: The OTC market offers a lot of well-known, large-cap stocks. Did you know that large multinational firms like Toyota, Deutsche Telekom, Heineken and Royal Dutch Shell all trade OTC in the United States? (ADR securities traded on a national exchange may also be available for some of these firms.)

Improved technology: The OTC market is continually improving, with better technology, including faster electronic price information.

U.S. trading hours: The U.S. OTC market lets investors trade foreign stocks during U.S. trading hours. This benefit is especially important when you want to manage and monitor your trading.

What are the drawbacks of the OTC market?

Cost premiums/wider spreads: Market makers will frequently mark up share prices, relative to the prices on foreign exchanges, to cover the risks they take in maintaining their inventories, such as currency risk, as well as to offset foreign trading and currency fees. Any such premium is reflected in the price you see (the bid/ask quote).

Availability: Not all foreign securities are available through the OTC market.

Liquidity and price volatility: Liquidity can vary widely, which can cause prices to fluctuate. You may not be able to locate the number of shares you want. You also may not be able to find a buyer or seller willing to trade at the price you want. Investors may find greater liquidity and better prices by trading directly on foreign stock exchanges.

Outdated quotes: Quotes for OTC stocks are not always up to date. In order to get the most accurate, up-to-date quote, call a Schwab Global Investing Specialist at 800-992-4685.

Commissions: Foreign ordinary shares that trade online in the U.S. OTC market are subject to a foreign transaction fee. For more information, see the Charles Schwab Pricing Guide.

Limited information: Reliable, timely or sufficient information regarding issuers of OTC securities may not exist or be difficult to obtain. As a result, it may be hard to properly value an investment in an OTC stock.

How do I get started?

The table below lists the 26 countries that are available for online trading at Schwab in the OTC market.

Foreign ordinaries traded OTC at Schwab online

Australia Indonesia Philippines
Austria Ireland Singapore
Belgium Italy South Africa
Canada Japan Sweden
Denmark Malaysia Switzerland
Finland Mexico Taiwan
France Netherlands Thailand
Germany New Zealand  United Kingdom
Hong Kong Norway  

 

What you should know

Trade execution: OTC trades are executed during regular US market hours. Orders can be placed, modified, or canceled during market hours.

Order types: Only market orders and limit orders are accepted. No stop orders are permitted, for either online or broker trades. (Stop orders are permitted for Canadian stocks.)

Time limits: Day orders or good-till-cancelled orders are accepted. Order qualifiers, such as "fill or kill" orders, are not accepted, even through brokers.

Quotes: Schwab provides real-time, intraday bid/ask quote data for OTC stocks. However, remember that quotes for OTC stocks are not always up-to-date, due to the different price reporting standards in place for the OTC market. As a result, a quote that you see may not always be accurate. In order to be certain, call a Global Investing Specialist at 800-992-4685 for an updated quote.

Margin: These securities are not marginable.

Currency used for transactions: All trades are quoted and settled in U.S. dollars.

Trade settlement: Most foreign ordinaries will settle in the foreign market where the company has its primary listing, regardless of where the trade is executed. Most foreign markets settle transactions on a T+3 schedule (that is, within three business days), similar to the United States. Some foreign markets have shorter settlement cycles.

For more information, call a Schwab Global Investing Specialist at 800-992-4685. Specialists are available to answer questions and place trades between 7 a.m. and 5:30 p.m. ET, Monday to Friday.

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