What Is the Over-the-Counter OTC Market and How Does It Work? Market Pulse

How securities are traded plays a critical role in price determination and stability. Over-the-counter markets are those where stocks that aren’t listed on major exchanges such as the New York Stock Exchange or the Nasdaq can be traded. More than 12,000 stocks trade over the counter, and the companies that issue these stocks choose to trade this way for what is an over the counter market a variety of reasons. The major regulatory reform underway in the United States, European Union, and other developed financial markets are directly addressing these issues. In others, post-trade clearing of OTC trades is moving to clearinghouses (also known as central clearing counterparties).

What are the risks of OTC trading?

Shares that are https://www.xcritical.com/ traded OTC tend to be cheaper than those listed on a centralised exchange. As a result, you can buy a lot of shares for a small amount of capital. Investing in OTC securities is possible through many online discount brokers, which typically provide access to OTC markets.

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A third market has developed because of the increased importance of institutional investors, such as the mutual funds, who deal in large blocks of stock. Trading is done in shares listed on the exchanges but takes place over-the-counter; that permits large-quantity discounts not possible on the exchanges, where brokerage fees are fixed. Contrary to trading on formal exchanges, over-the-counter trading does not require the trading of only standardized items (e.g., clearly defined range of quantity and quality of products). OTC contracts are bilateral, and each party could face credit risk concerns regarding its counterparty. Over-the-counter (OTC) is the trading of securities between two counterparties executed outside of formal exchanges and without the supervision of an exchange regulator. OTC trading is done in over-the-counter markets (a decentralized place with no physical location), through dealer networks.

Why Are Certain Stocks Unlisted?

• Thus, the risk of speculation and unexpected events can hurt the stability of the markets.
• The term “Pink Sheets” derived from the pink-colored paper on which the bid and ask prices of these securities were printed and circulated.
• Glaspie pleaded guilty in 2023 to defrauding more than 10,000 victims of over $55 million through his “CoinDeal” investment scheme.
• In addition to the decentralized nature of the OTC market, a key difference is the amount of information that companies make available to investors.
• The OTC marketplace is an alternative for small companies or those who do not want to list or cannot list on the standard exchanges.

It consists of stocks that do not need to meet market capitalisation requirements. OTC markets could also involve companies that cannot keep their stock above a certain price per share, or who are in bankruptcy filings. These types of companies are not able to trade on an exchange, but can trade on the OTC markets. Stocks and bonds that trade on the OTC market are typically from smaller companies that don’t meet the requirements to be listed on a major exchange. In the United States, over-the-counter trading of stocks is carried out through networks of market makers. The two well-known networks are managed by the OTC Markets Group and the Financial Industry Regulation Authority (FINRA).

Investors also face greater counterparty risk—the risk that the other party in a trade may default. Prices can vary, and buyers often face wider bid-ask spreads due to lower liquidity. This OTC definition highlights that trades happen via private negotiations, often facilitated by brokers or dealers. Over-the-counter trading take place on a decentralised market, with no single physical location, and participants trade through various means such as email, telephone and proprietary electronic trading systems. An exchange market and an OTC market are the two primary ways of formulating financial markets.

Many of the largest financial markets in the world do not organize trade through an exchange but rather operate within a decentralized or over-the-counter (OTC) structure. However, standard models of financial markets are not suitable for studying the causes of illiquidity in OTC markets, nor the optimal policy response. What’s more, she’s also better off narrowing her search and speaking to a small number of counterparties. Other larger companies are traded OTC because they’ve been delisted from the exchanges for failing to continue to meet listing standards.

If you want to compare other brokers, check out the best brokers for stock trading. There’s a possibility that there could be fraud at the very lowest level of the pink sheet market,” he says. An example of an OTC platform is OTC Markets Group, which facilitates the trading of unlisted stocks through tiers like OTCQX, OTCQB, and Pink Open Market. A current rule from the Commodity Futures Trading Commission (CFTC) mandates that investors in over-the-counter markets contact a minimum number of potential counterparties when looking to trade.

In the United States, OTC trading in stock takes place by using market makers and inter-dealing quotation services such as OTC Bulletin Board (OTCBB) and OTCLink. Commonly over-the-counter stocks are not traded or listed on exchanges. Stocks that are quoted on the OTCBB must adhere to certain limited U.S Securities and Exchange Commission (SEC) reporting and regulation requirements. Some companies began by trading OTC stock and eventually upgrading to the fully regulated markets, the most famous of these companies being WalMart. For a lot of investors, there is little difference between OTC vs exchange trading. Advancements in electronic trading have provided higher liquidity and a better standard of information.

An advantage of the OTC market is that non-standard quantities of stock or shares can be traded. As we’ve seen, some types of stocks trade on the OTC markets for very good reasons, and they could make excellent investment opportunities. On the other hand, many OTC stocks are issued by highly speculative businesses or even outright fraudulent companies involved in pump-and-dump scams.

They found that the model could no longer explain investors’ observed behavior. In other words, without front-running, there was no reason why investors would contact so few dealers. OTC Markets Group, the largest electronic marketplace for OTC securities, groups securities by tier based on the quality and quantity of information the companies report. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result.

The NYSE requires all its listed companies to have 1.1 million publicly held shares. These must be held by a minimum of 2,200 shareholders and the minimum share price must be $4.00. Another factor with OTC stocks is that they can be quite volatile and unpredictable. They can also be subject to market manipulation, so risk management techniques are recommended when trading over-the-counter. A stop-loss order will automatically close a position once it moves a certain number of points against the trader.

Let’s say a small company wants to sell its stock but doesn’t meet the prerequisites of an exchange, such as reaching a minimum share price or having a certain number of shareholders. Since bonds are typically issued in large quantities and often have specific terms, the OTC market allows for more flexibility and customisation compared to exchanges. This also includes municipal bonds, which are important for financing public projects​. Counterparty risk is the risk that one of the parties involved in a transaction will default before the end of the trade and will not meet all current and future payments required by the contract. There are various ways to limit this sort of risk, one of them being the control of credit exposure with diversification, hedging, collateralisation and netting.

Dealers behave as market makers in OTC markets by quoting the prices at which they’ll buy and sell a currency or security. These include price per share, corporate profits, revenue, total value, trading volume and reporting requirements. Shareholders and the markets must be kept informed on a regular basis in a transparent manner about company fundamentals. In the over-the-counter market, dealers frequently buy and sell for their own accounts and usually specialize in certain issues.

One example of an over-the-counter market is the NASDAQ, which lists many of the more actively traded OTC stocks. These stocks are not traded on a traditional exchange like the New York Stock Exchange (NYSE), but rather through the NASDAQ’s electronic trading system. Stock exchanges impose strict listing conditions on securities to be listed and accept only those that meet these conditions, so relatively, not as many securities can be exchange-traded. It operates through a global, decentralised network where currencies are traded directly between participants, rather than through a central exchange. Retail traders access this market via brokers, allowing them to trade currency pairs 24/5.

A limit will close a position once it moves a certain number of points in favour of the trader. For both types of orders, traders can set triggers at predetermined price levels so they can define their profit and loss amounts in advance. Larger, established companies normally tend to choose an exchange to list and trade their securities on.

Exchanges, whether stock markets or derivatives exchanges, started as physical places where trading took place. Some of the best known include the New York Stock Exchange (NYSE), which was formed in 1792, and the Chicago Board of Trade (now part of the CME Group), which has been trading futures contracts since 1851. Today there are more than a hundred stock and derivatives exchanges throughout the developed and developing world. Financial markets are complex organizations with their own economic and institutional structures that play a critical role in determining how prices are established—or “discovered,” as traders say. These structures also shape the orderliness and indeed the stability of the marketplace.

The role of the dealer in OTC markets is not, however, being explicitly addressed except through possibly higher capital requirements. Penny stocks and other OTC securities are readily available for trading with many of the online brokerages, these trades may be subject to higher fees or some restrictions. OTC trading gives companies that don’t meet stock exchange requirements the opportunity to raise capital, which can help fund expansion and growth.

Usually, a trader has the OTC security, then it goes to a broker-dealer, and then the broker-dealer trades it to the person who’s buying it. The security’s price isn’t listed publicly as it would be on an exchange regulated by the Securities and Exchange Commission, says Brianne Soscia, a CFP from Wealth Consulting Group based in Las Vegas. By contrast, an OTC equity issuer may or may not be required to file these reports. Some OTC equity issuers do file regular reports with the SEC like listed companies, and some non-SEC reporting OTC equity issuers might make certain financial information publicly available through other avenues. This means information available to investors about the company could be limited or incomplete. OTC trades in exchange-listed stocks—whether occurring on an ATS or otherwise—must be reported to a FINRA Trade Reporting Facility (TRF).

It’s for this reason that Mollner believes the CFTC rule mandating a minimum number of counterparty contacts needs to go. He and Baldauf also suggest that electronic trading platforms adjust the information they require investors to disclose. The researchers used a mathematical model to represent the interaction between an investor looking to buy or sell assets on the OTC market and a dealer who might fulfill the trade. Here’s a rundown of how the over-the-counter stock markets work and the types of securities you might find on the OTC markets.