OTC simply means Over-the-Counter, which is a common term people use. But, what is an OTC market. Well, this is a decentralized market that does not have a central physical location. In this scenario, the traders trade with each by communicating through modes such as email, telephone, and even the proprietary trading systems.
Generally, in an OTC market, the dealers will act as the market markers whereby they quote the prices at which the buy and sell of the security, currency or other financial products happen. The trade is then executed without the others in the market being aware of the price that the transaction was completed with. Well, due to this nature, the OTC markets are often seen to be less transparent than the exchanges. Also, they are subjected to fewer regulations.
Uses of OTC Markets
The OTC markets are popular for trading bonds, derivatives, currencies, and structured products. In other places, you can also find them trading equities such as the OTCQB, OTC Pink and OTCQX. In the U.S. these OTC markets are regulated by the Finance Industry Regulatory Authority. This means that you might want to check for relevant certifications before using the specific OTC.
The OTC markets are also bifurcated to work as customer market. This is where the dealers would trade with the clients including institutions and corporations. Make sure you understand all the rules that apply to the OTC markets before investing your money.
The risks of OTC Markets
As much as OTC markets can function good during the normal time, there are still some risks involved. The most common being counter-party risk. This is where one party in the transaction will go ahead to default prior to the completion of the stipulated trade. The trader can also fail to make current and future payments as required by them in the contract. Generally, the lack of transparency will definitely lead to a vicious cycle that can develop during the financial stress times.
How to Trade OTC Markets
Well, if you want to start trading OTC markets, the first thing you have to do is open an account with a brokerage firm. You can choose to invest with a discount broker or simply a full-service broker. You need to be aware that not all the brokers would allow for trading in OTC securities. With a bit of research, you can always find the right broker that would work for you.
With any good OTC market broker, you should be able to learn more about your options before you can make the investment. No one wants to end up losing their money easily.
How OTC Stocks are different
The major stock exchanges would generally have stringent listing requirements. These are the important requirements that different companies have to meet before being traded. It is the reason you can find a company being delisted even after being traded for years. Once delisted, these shares will have to be traded on another platform. Generally, the tens of thousands of the small companies will often be traded on the OTC exchanges all around the world.
Also, most common stocks that have real potential are often priced over $15 per share will be listed on NYSE. However, those stocks with a price below $1, they will trade over-the-counter. Such stocks would have a murkier financial outlook and would often be very speculative and further risky.