Solving the mystery of over-the-counter (OTC) trading

  • # trade

  • # forex

  • # invest

  • Published: Nov 10, 2022

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OTC markets are electronic networks allowing two parties to trade with each other using a dealer-broker as the middleman.

It is essentially the stock market version of “for sale by owner,” which lets market players trade stocks, bonds, and other financial instruments outside formal exchanges without the supervision of an exchange regulator.

In addition to stocks, this type of trading can involve bonds, debt instruments, currencies, and derivatives, financial contracts that derive their value from the underlying asset, such as a commodity.

How do otc markets work

Since several small companies and businesses cannot conform to the stringent norms mandated by formal exchanges for listing securities, these businesses typically opt for OTC mechanisms for security trading.

Stock exchanges like the Nasdaq or New York Stock Exchange (NYSE) are strictly regulated by the Securities Exchange Commission (SEC), while no governing institution observes OTCs. That said, there are still federal regulatory hoops to jump through.

OTC trading is normally carried out through a licensed broker-dealer, which is regulated by FINRA (the Financial Industry Regulatory Authority).

Trade transactions can take place through OTC Markets Group’s electronic matching platform, which includes the OTCQX, OTCQB, and the OTC Pink marketplaces (previously the OTC Bulletin Board and Pink Sheets) in the U.S.

How to buy stocks on the otc market

Much like any other product, the over-the-counter (OTC) market allows interested buyers to search for a product with a maximum price they are willing to pay. If an owner of a product has a minimum price they are willing to accept, and the buyer’s maximum price is above the seller’s minimum price, a transaction can occur.

Firstly, to buy a security on the OTC market, traders need to identify the specific security they want to purchase and the amount they want to invest.  Then, find a broker through which you can buy the OTC security. If you already have a broker and account set up, the security purchase can be done electronically on your broker’s platform.

Risks of otc trading

OTC stocks have less liquidity than those listed on stock exchanges. Combined with a lower trading volume and bigger spreads between the bid price and ask price, these stocks are subject to more volatility.

Theoretically, a seller could be charging a buyer one amount for a security and naming another price to another buyer, giving the price a lack of transparency.

The lack of regulation in the OTC market also provides opportunities for scammers to promote and encourage people to buy penny stocks so that the price will rise. Once a stock hits a certain price, the promoter might then sell the shares, causing the stock price to plummet and leaving investors with losses.

Though OTC creates many alternative opportunities, most financial advisors consider trading in OTC shares as a speculative undertaking. Due to its shady reputation, traders should thus note the risks involved and do thorough research before investing in these companies.