What Are OTC Markets?
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 do 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.
Securities traded over the counter are most often facilitated by an OTC markets broker. This market and its brokers promote stocks and other financial instruments to investors that otherwise would have remained unavailable for them to invest. Companies that do not fulfill requirements to list on exchanges such as New York Stock Exchange (NYSE) are traded as OTC shares.
Table of contents
- OTC markets are where direct trading in securities and other instruments occurs between two parties, with or without the help of private dealers.
- Decentralized markets include the over-the-counter (OTC) market. There needs to be a physical center for it. The parties involved do business and communicate through various channels, including email, telephone, and proprietary computerized trading systems.
- OTC Markets Group has updated “pink sheet” trading to include OTC Pink, OTCQB, and OTCQX. It allows the trading of equities outside of traditional regulations.
OTC Markets Explained
OTC markets refer to the shares that are not listed on the exchange. They are traded over the counter. When companies cannot fulfill all requirements to be listed on exchanges such as NYSE, they are traded in this manner. The Securities and Exchange Commission (SEC) still might impose some regulations upon them.
The Over-the-counter (OTC) market is a decentralized market. It does not have a central physical location. The trade and communication between the parties involved occur through various modes such as email, telephone, and proprietary electronic trading systems.
The prices for OTC market trading 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 account, matching orders internally, 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.
All the brokers and dealers involved in over-the-counter trading in the United States must register with the Financial Industry Regulatory Authority, Inc.(FINRA). Retail investorsRetail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making. should execute their transactions (buy and sell orders) in OTCQX, OTCQB, and Pink securities with the help of a FINRA-registered broker-dealer.
Let us discuss the different types of asset classes that are purchased and sold through an OTC markets broker through the discussion below.
- Stocks: Most companies that are traded over the counter are ones that do not qualify to be listed on exchanges. Naturally, they are relatively smaller companies that do not have the capital or resources to grow multifold immediately or their nature of business might prevent them from fulfilling all requirements.
- Derivatives: These are private contracts facilitated by brokers which can be futures, options, or forwards based on an underlying asset such as a commodity or a stock.
- Bonds: Since bonds cannot be traded on the exchange, it is traded through a network filled with brokers and dealers. They are also commonly referred to as OTC securities.
- American Depository Receipts (ADRs): ADRs or bank certificates determine that an individual or institution has holdings in a foreign company. The price, number of shares, and dates are mentioned in the certificate.
- Cryptocurrency: In modern times, block-chain linked coins such as Bitcoin, Ethereum, Solana, and others are traded over the counter as well.
- Currency: Foreign currencies that are traded on the foreign exchange or forex are also traded over the counter with the help of a broker. In the era of the internet, many private players also directly facilitate the trading of currencies.
Formerly, over-the-counter trading was referred to as “pink sheetPink SheetPink sheets are stocks that cannot be traded on exchanges such as NYSE/NASDAQ for a variety of reasons, including a lack of sufficient capital to go public, lack of economic justification for going public given the small amount of capital they intend to raise, or a strategic decision not to go public due to the scrutiny that the regulatory boards place on them.” 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 called OTC pink sheets, is the most unregulated and open platform of all trading marketplaces. It does not lay any rules for the companies to get listed here, and also, the companies need not file with the Securities Exchange Commission. The only requirement is to obtain quotes from a broker-dealer registered with the FIRA.
The features mentioned above of an OTC pink marketplace provide a trading platform for domestic or foreign companies that limit their disclosure in the U.S., penny stocksPenny StocksPenny Stock refers stocks of public companies that trade at a very low price, typically less than $5 per share and are highly illiquid. Usually, these stocks belong to small and newbie companies with a low market capitalization., and distressed, delinquent companies not willing or able to provide information to potential investors.
Therefore, the investors need to be professional and highly sophisticated with a high-risk tolerance for trading in companies with 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 they are interested in before making any investment decisions.
#2 – OTCQB
OTCQB, which hosts the Venture Market, is the second tier of the OTC Market Group. The listed companies are generally small and in the growth phase of their life cycle. Companies that start trading in the OTCQB marketplace 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 less transparent than their established counterparts, so this poses a threat to the investors who conduct trades without investment acumen. Therefore, investors are advised to be diligent when investing their capital in the companies listed on the QTCQB marketplace.
#3 – OTCQX
The OTCQX, the highest tier in the OTC Market Group, includes multinational corporations, stocks of blue-chip companiesBlue-chip CompaniesBlue chip stocks are issued by companies possessing large market capitalization. Blue chip companies are market leaders. They provide good returns on stocks, offer dividends, and are considered safe investments., and groups that must prove their integrity to investors. 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 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 is a connection for any company looking to trade on an OTC Market Group network. Quotes, i.e., ask and bid pricesBid PricesBid Price is the highest amount that a buyer quotes against the “ask price” (quoted by a seller) to buy particular security, stock, or any financial instrument. , are obtained or published from a system maintained by the Over The Counter Markets group.
Let us understand the advantages of OTC markets trading through the explanation below.
- OTC markets are decentralized, allowing 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 stock 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 marketplace.
- The investors pay fewer trade costs so that they can achieve a significant level of return.
Despite the various advantages mentioned in the section above and throughout the article, there are a few factors from the other end of the spectrum that prove to be a hassle for players and OTC markets brokers. Let us understand the disadvantages through the points below.
- There is a greater risk of fraud due to the lack of regulation.
- The prices of 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 investors in trading stocks that would otherwise not be available on stock exchanges.
Frequently Asked Questions (FAQs)
Broker dealers that conduct business in the over-the-counter (OTC) market are subject to regulation by the Financial Industry Regulatory Authority (FINRA).
OTC trading occurs directly between parties without a centralized exchange. Exchange trading involves a centralized platform where buyers and sellers meet to execute orders.
As opposed to trading on a centralized exchange like the New York Stock Exchange, over-the-counter (OTC) trading involves the sale of securities through a broker-dealer network. OTC networks have eligibility restrictions set by the SEC while not being regulated exchanges.
OTC prices are determined through negotiations between buyers and sellers. The lack of centralized pricing can lead to price discrepancies between different transactions.
This has been a guide to what are OTC Markets. Here we explain over-the-counter market groups, types, advantages, and disadvantages. You can learn more from the following articles –