One way or another, traders interact with exchanges – stock, currency, cryptocurrency or commodity. But market relations also exist outside of these institutions. If we take an everyday example, then you will most likely buy branded items from a new collection in an official store, and collectible antiques – from someone’s hands.

A similar phenomenon exists in trading. The over-the-counter market, or OTC (over-the-counter) market is an alternative platform for trading securities that are not admitted to quotations on major exchanges. This market concentrates issues, as a rule, of small companies that don’t meet the listing requirements. A characteristic feature of the over-the-counter market is the participation of market makers who provide two-way quotations and facilitate the conclusion of transactions.

In this regard, trading on the over-the-counter market may differ from exchange trading in procedural aspects and the level of commission fees. Let’s take a closer look at how the OTC market works.

How does the OTC market work?

The OTC market is a decentralized trading platform where securities are traded outside of organized exchanges. This segment of the financial market unites more than 12,000 different instruments, including stocks, exchange-traded funds, bonds, commodity derivatives, and others.

Unlike traditional exchanges, such as the New York Stock Exchange, the OTC market doesn’t have a physical embodiment. All trading operations are carried out electronically directly between market participants without the mediation of a centralized exchange.

Despite the fact that securities traded on the OTC market are not listed on exchanges, issuers have the opportunity to publicly offer their shares. For investors, the procedure for purchasing OTC securities is often no different from buying shares listed on organized exchanges: each security is assigned a unique ticker, and trading is carried out through familiar online brokerage platforms.

The OTC market is the primary trading venue for a range of financial instruments, such as corporate bonds. It also serves as an alternative for companies that don’t meet or don’t wish to meet the strict listing requirements of organised exchanges. Some companies deliberately choose to trade OTC to avoid listing fees and regulatory restrictions.

Differences between the OTC market and stock exchanges

The OTC market differs significantly from organised stock exchanges in a number of key ways.

One of the most significant differences is the level of transparency. While stocks listed on formal exchanges are accompanied by extensive information support, including research, company news and trading volume data, OTC securities are characterized by a significantly lower level of disclosure. This limited transparency, combined with weaker regulation, increases investment risks and creates conditions for potential manipulation. In addition, OTC stock quotes may be less accurate and more volatile due to limited liquidity.

A typical example of high-risk OTC assets are so-called “penny stocks” – stocks with extremely low prices. These securities are often associated with fraudulent schemes and high losses for investors.

However, the OTC market also serves an important function, providing investors with access to shares of foreign companies through American Depository Receipts (ADRs). Although ADRs are traded over the counter, this doesn’t mean that they are an increased investment risk.

3 main OTC markets

Although the OTC market is traditionally associated with less regulation and lower disclosure requirements compared to organized exchanges, not all securities traded on this market are created equal.

OTC Markets Group, the leading electronic trading platform for OTC securities, classifies instruments according to the quality and volume of information provided by issuers. This classification is not a direct indicator of the company’s investment attractiveness, but it allows investors to assess the degree of transparency and availability of information about a particular security.

Most often, three market levels are defined:

  • OTCQB Venture Market: Designed for young, developing companies that may not meet the strict requirements for inclusion in a higher-level quotation list. The requirements for companies listed on this market are less stringent, but they must meet minimum financial reporting standards.
  • OTCQB Best Market: Includes more mature and financially stable companies that meet increased disclosure requirements. Companies listed on this market demonstrate a higher degree of transparency and reliability.
  • Pink Open Market: This is the riskiest segment of the OTC market. Companies listed on this market provide minimal information and may not comply with the requirements of the US Securities and Exchange Commission. Due to the low level of regulation and transparency, this market has a high probability of fraudulent schemes and financial losses for investors.

Understanding the risks of OTC securities

Over-the-counter securities are characterized by a higher level of investment risks compared to shares listed on regulated exchanges. The lack of strict disclosure and listing requirements makes this market segment less transparent and predictable.

Limited availability of information is one of the key problems of the OTC market. Investors often find it difficult to obtain reliable and up-to-date data on the financial condition and development prospects of companies whose shares are traded on this platform. This creates conditions for market manipulation and increases the likelihood of investment losses.

The lack of uniform listing standards is another factor that increases risks. Unlike organized exchanges, where companies are required to comply with strict disclosure and financial reporting requirements, the OTC market may not have such requirements. Although some trading platforms, such as OTCQX and OTCQB, set certain standards, they are much more lenient compared to exchanges.

High volatility and low liquidity are also characteristic of the OTC market. Small-cap (micro-cap) stocks, which often trade over the counter, are particularly susceptible to sharp price swings due to low trading volumes. This makes investing in these stocks extremely risky.

Is the OTC market safe?

The OTC market is traditionally associated with increased investment risks due to less stringent requirements for financial disclosure and the lack of centralized control over trading operations.

Many securities traded on the OTC market have relatively low prices, which attracts speculative investors seeking to make a quick, high profit. However, it should be remembered that a low share price does not always indicate that it is undervalued and may be explained by fundamental problems of the company.

Despite the increased risks, the OTC market provides investors with an opportunity to purchase shares of companies at an early stage of development. Some companies that started their history on the OTC market subsequently move to quotations on organized exchanges, which can bring investors significant profits. However, it is worth considering that not all companies traded on the OTC market demonstrate positive dynamics. Many of them experience financial difficulties and may go bankrupt.

When deciding to invest in OTC securities, it is necessary to carefully weigh all the pros and cons. Classification of OTC stocks by tiers (e.g. OTCQX, OTCQB, Pink) can provide a general idea of ​​investment risks, but isn’t a comprehensive tool for making investment decisions. Investors are encouraged to conduct in-depth analysis of each specific company, study available financial statements, analyze industry trends, and consult with professional financial advisors.

Why trade on the OTC market?

OTC markets provide a platform for companies that don’t meet the strict listing criteria of major exchanges. These young, dynamic businesses often offer investors a unique opportunity to earn higher returns, but also with a higher level of risk.

Compared to traditional exchanges, OTC markets offer greater flexibility in trading. Participants can make trades on individual terms, varying the volumes and settlement times in accordance with their specific requirements. This flexibility is especially sought after by institutional investors and those who carry out large transactions.

Less stringent regulatory requirements and simplified reporting are another advantage of OTC markets. This significantly reduces the cost of raising capital for companies and simplifies this process.

Over-the-counter trading in different markets

Over-the-counter trading is a multifaceted financial instrument implemented in various markets. Despite the diversity, they all have one common principle: transactions are concluded directly between market participants without the mediation of a centralized exchange.

The Forex market is the most striking example of over-the-counter trading. Traders in this market buy and sell currency pairs, directly interacting with each other. This format provides high flexibility and allows for transactions on favorable terms.

The commodity market also actively uses over-the-counter trading mechanisms. Large companies, such as banks and energy giants, conclude transactions for the direct delivery of physical goods, such as oil, gold or agricultural products. This allows for the optimization of logistics processes and the reduction of costs.

The stock market also offers opportunities for over-the-counter trading. Companies that aren’t listed on major exchanges can directly place their shares with investors. This is especially relevant for smaller companies seeking to raise capital.

Participation in OTC trading requires a deep understanding of its features and associated risks. The lack of centralized regulation and the high degree of flexibility of transactions create both opportunities and threats for traders.

To successfully trade on OTC markets, it is necessary to constantly improve your skills, study market trends and analyze financial instruments. Only a comprehensive approach will allow you to make informed decisions and minimize risks.