SecondForge

I have dedicated a portion of my portfolio to ‘picocap’ (under $50 million of market capitalization), over-the-counter-traded companies. This post is part of a series of reflections on beginning to invest in these companies.

Most traders and investors will be familiar with the idea of “NBBO”, or “national best bid and offer”, a Securities and Exchange Commission-created term that refers to the best bid for a particular stock across all exchanges, and the corresponding best offer.

That is, if the highest-price buy limit order placed is for $10.00 per share for 100 shares, and the lowest-price sell limit order placed is 100 shares for $10.02 per share, the NBBO is $10.00 x 1 - $10.02 x 1 (1 being short for 100 shares, or 1 lot).

However, in the wild west OTC markets, where the spread can easily be 10 or 20% of the share price, there’s a particular rule you should be familiar with - miniumum quotation sizes.

FINRA rule 6433 establishes minimum quotation sizes for orders.

To be posted, your order must be at least this large:

$0.0001-$0.0999 per share: 10,000 shares $0.10 - $0.1999 per share - 5,000 shares $0.20 - $0.5099 per share - 2,500 shares $0.51 - $0.9999 per share - 1,000 shares $1.00 - $174.99 per share - 100 shares

That is, if you enter a limit order for $0.50 per share for a stock for 1,000 shares, your order will not be posted to the market, unless, potentially, your order is combined with another equal-priced limit order at the same routing dealer - which, in these exchanges, is only somewhat likely. I don’t have a clear idea of how that would work.

Your limit order will still be accepted, though, so if the ask then crosses your limit, it’ll be executed - but presumably, you entered your limit buy because you didn’t just want to hit the ask.

There are several effects of this rule:

First, this establishes an effective dollar-minimum order size for investors who do not want to pay the spread:

$0.0001 - $0.0999 per share: up to $999 $0.10 - $0.1999 per share: $500 to $999.5 $0.20 - $0.5099 per share: $500 to $1274.75 $0.51 - $0.9999 per share: $510 to $999 $1.00 - $174.99 per share: $100 and up

That is, if you want to avoid paying the spread - which, remember, for these OTC stocks, can easily be 10-20% of the share price - you need to have, generally, about $1000 to $1250 to enter the position.

Second, certain normal behaviors, including partial fills, make trading much more expensive.

Consider a small trader who wants to open a minimum-sized position in a stock trading around $0.40 per share. He or she enters an order for 2500 shares at $0.4010 for 2,500 shares, for $1002.5 order size.

A few minutes later a market order for 2 lots comes through, giving a partial fill. This reduces the order size to 2,300 shares, putting it below the minimum size and taking it off the board.

At least with Fidelity, you cannot increase the share count for a partially filled limit order, so you are only left with the option of cancelling the order and entering a new one, which means paying two commissions - effectively paying a $4.95 commission for a 200 share, $80 order.

To deal with this, you may consider entering orders that are larger than the position you may want to open, and cancelling them if you end up with a partial fill. Ideally, this order would be at least twice the minimum, so in the event of a full fill, you can post a minimum-size ask and maybe make the spread.

Finally, you may consider asking your broker about the exact minutiae of their order-edit rules and how commission is charged, to avoid over-paying for many partial fills on limit orders.