OTC Markets Meaning
The meaning of OTC Markets is that these are the markets where trading of financial securities like commodities, currencies, stocks, derivatives, etc. and other non-financial trading instruments does not take place on recognized stock exchanges and instead takes place over the counter i.e. directly between the two parties involved, with or without the help of private securities dealers.
OTC Markets Functioning
Over-the-counter (OTC) market is a decentralized market and does not have a central physical location and the trade and communication between the parties involved takes place through various modes such as email, telephone, and proprietary electronic trading systems.
The prices are dependent on the supply and demand in the market. The parties involved buy and sell securities at certain prices with or without the help of broker-dealers who provide liquidity by trading for their own account and matching orders internally or publishing quotes and executing with external broker-dealers. The price of securities and other non-financial instruments are affected by the availability of information about the number and volume of orders (i.e. the liquidity of underlying stock), and the timing of buy and sell orders.
In the United States, all the brokers and dealers involved in over the counter trading must register with Financial Industry Regulatory Authority, Inc.(FINRA). Retail investors should execute their transactions (buy and sell orders) in OTCQX, OTCQB, and Pink securities with the help of a FINRA-registered broker-dealer.
OTC Markets Group
Formerly, over-the-counter trading was referred to as “pink sheet” trading. But these old pink sheets have been re-categorized by the OTC Markets Group into the present-day OTC Pink, OTCQB, and OTCQX.
#1 – OTC Pink
The pink open market, also referred to as OTC pink sheets are the most unregulated and open platform of all trading marketplaces. It does not lay any rules for the companies in order to get listed here and also the companies need not file with the Securities Exchange Commission. The only requirement is that they need to obtain quotes from a broker-dealer registered with the FIRA.
The aforementioned features of an OTC pink marketplace provide a trading platform for domestic or foreign companies, that limit their disclosure in the U.S., penny stocks, as well as distressed, delinquent, companies not willing or able to provide information to the potential investors.
Therefore, the investors need to be professional and highly sophisticated with a high-risk tolerance for trading in companies that have limited information available to the public. Also, due to the limited regulatory oversight, it is strongly recommended that the investors proceed with great caution and thoroughly research the listed OTC pink companies that they are interested in before making any investment decisions.
#2 – OTCQB
OTCQB which hosts the Venture Market is the second tier on the OTC Market Group. The companies that are listed here are generally small and in the growth phase of their life cycle. In order for companies to start trading in the OTCQB marketplace, they are subject to a set of regulations. The requirement to fulfill a minimum set of standards reduces the possibility of Penny stock companies and fraudulent corporations from getting listed in the QTCQB marketplace.
The companies trading here are open natured and are less transparent than their established counterparts and so this poses a threat to the investors who conduct trades without investment acumen. The investors are therefore advised to be diligent when investing their capital in the companies listed on the QTCQB marketplace.
#3 – OTCQX
The OTCQX which belongs to the highest tier in the OTC Market Group includes multinational corporations, stocks of blue-chip companies, and groups that are required to prove their integrity to investors. In order to get listed on the OTCQX, companies must go through stringent disclosure requirements. The companies of the OTCQX must fully comply with laws put forth by the US Securities Exchange Commission. These stringent policies safeguard the interests of the investors as penny stocks are excluded.
Although the listed companies undergo strict scrutiny, trades remain private. Due to the decentralized nature of the OTCQX, there is scope for speculative investments and these investments are therefore considered to be a little risky. Despite the level of risk, many investors enjoy incredible returns in the OTCQX.
It is to be noted the amount of risk is far less than the other two marketplaces. Here, the companies would undergo verification that is very similar to what they would face with a recognized stock exchange.
#4 – OTC Link
The OTC link is a service owned and operated by the OTC Markets Group and provides a link for traders and companies on each of the three marketplaces discussed above. OTC Link acts as a connection for any company looking to trade on an OTC Market Group network. Quotes i.e. ask and bid prices are obtained or published from a system maintained by the Over The Counter Markets group.
- OTC markets are decentralized and so they allow for the free trade of securities between parties involved without the interference of outside parties.
- The traders in the OTC markets are free to set the prices and the broker deals on their own.
- OTC provides access to securities or stock not available on standard exchanges.
- OTC markets impose fewer regulations.
- Penny stock companies and other small companies that don’t get listed on recognized stock exchanges can get listed in the OTC market place.
- The investors pay less trade costs and so they can achieve a significant level of return.
- There is a greater risk of fraud due to the lack of regulation.
- The prices of the securities or other non-financial instruments are highly volatile.
- OTC markets pose a threat of low liquidity.
- There can be delays in finalizing the trade.
- OTC markets lack transparency.
In a nutshell, OTC trading is an unregulated form of a trading system that promotes equity and thereby helps the investors in trading in those stocks that would otherwise not be available on the standard exchanges.
This has been a guide to OTC Markets and its meaning. Here we discuss the top 4 over the counter market group along with its functioning, advantages, and disadvantages. You can learn more from the following articles –