Understanding Over-the-Counter OTC Markets: Benefits and Risks

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. Securities traded on the over-the-counter market are not required to provide this level of data. Consequently, it may be much more challenging to understand the level of risk inherent in the investment.

These markets often lack the regulations, transparency, and liquidity of exchanges. OTC trades in exchange-listed stocks—whether occurring on an ATS or otherwise—must be reported to a FINRA Trade Reporting Facility (TRF). This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision.

• These so-called “gray market” transactions might happen through a broker with direct knowledge of a buyer and seller that may make a deal if they are connected.
• OTC securities, meanwhile, often have very low liquidity, which means just a few trades can change their prices fast, leading to significant volatility.
• OTC trading is for large, institutional-level trades, typically handled by a professional dealer.
• This has made the OTC markets a breeding ground for pump-and-dump schemes and other frauds that have long kept the enforcement division of the U.S.

RHC is not a member of FINRA and accounts are not FDIC insured or protected by SIPC. Brokerage services are offered through Robinhood Financial LLC, (RHF) a registered broker dealer (member SIPC) and clearing services through Robinhood Securities, LLC, (RHS) a registered broker dealer (member SIPC). That is why companies listed on an exchange are required to provide a lot of details about their finances, activities, and management. This information must be audited and accurate, or else they can face criminal charges.

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Suppose you’re an investor seeking high returns on your investments, so you’re willing to dip into the OTC markets if you can find the right stock. You look to be in early on what promises like a big deal, just like other storied early investors. After evaluating the quotes and considering the company’s prospects, MegaFund buys 30,000 shares from OTC Securities Group at $0.85 per share. The trade is executed directly between MegaFund and OTC Securities Group through a private negotiation. No public announcement is made about the transaction, and the price isn’t displayed on any exchange. The trading process during this era was cumbersome and inefficient.

A few types of securities that trade on the OTC markets can potentially make good investments. Historically, the phrase trading over the counter referred to securities changing hands between two parties without the involvement of a stock exchange. However, in the U.S., over-the-counter trading is now conducted on separate exchanges.

On the OTC, it is possible to find stocks, debt securities, and derivatives that usually are not traded over traditional stock exchanges. For example, you’ll often find international stocks (including many large and well-known companies) listed on the OTC markets. Stocks listed on U.S. exchanges that primarily trade in foreign markets are known as American Depository Receipts, or ADRs. The OTC market gives investors access to alternative securities, including shares of smaller companies that are lesser known and may be undervalued.

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• On public exchanges, large orders can telegraph intent and cause adverse price movement.
• These smaller, growing companies can sometimes provide investors with the potential for higher returns, although this comes with higher risk.
• On the other hand, many OTC stocks are issued by highly speculative businesses or even outright fraudulent companies involved in pump-and-dump scams.
• A host of financial products trade OTC, including stocks, bonds, currencies and various derivatives.

This allows investors to diversify their portfolios and gain exposure to international markets and companies that may not be available through traditional exchanges. That’s just one use of OTC markets, which involve two parties trading either directly or through broker-dealers rather than on a centralized exchange. Securities traded on OTCs include stocks—many are also listed on U.S. exchanges—bonds, derivatives, and cryptocurrencies. Often, the derivatives are complex instruments such as credit-default swaps on mortgage-backed securities, whose trading on the OTC markets played a key role in the global financial crisis. While many companies that trade OTC have share prices under $5 (called penny stocks), that’s not always the case. There are a variety of other reasons the company may not be able to meet the requirements of an exchange.

OTC Markets tiers

This trend is highlighted by BIS data, which showed the total notional value of just OTC derivatives climbing past the $667 trillion mark by the end of 2023. This level of flexibility stands in stark contrast to the rigid standardization seen in exchange-traded futures. Think of an OTC contract, like a swap or a forward, as a blank canvas whose terms can be negotiated with precision to meet the exact needs of the parties involved. The core difference between an OTC market and a centralized exchange lies in its structure. It matches all buy and sell orders using a central limit order book and provides complete price transparency to the public.

Over-the-counter (OTC) markets are stock exchanges where stocks that aren’t listed on major exchanges such as the New York Stock Exchange (NYSE) can be traded. The companies that issue these stocks choose to trade this Indices Trading Strategies way for a variety of reasons. For foreign companies, cross-listing in OTC markets like the OTCQX can attract a broader base of U.S. investors, potentially increasing trading volume and narrowing bid-ask spreads. Some foreign companies trade OTC to avoid the stringent reporting and compliance requirements of listing on major U.S. exchanges. OTC markets are regulated but have less strict listings, making them attractive to companies wanting U.S. investors without SEC registration. There are a number of reasons why a company’s stock might be unlisted.

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Yes, OTC markets are perfectly legal and are a vital part of the global financial system. They operate with less formal regulation compared to public exchanges. These strategies can be as simple as dealer-to-dealer arbitrage, which involves exploiting small price differences by buying from one desk and selling to another. A more common approach is OTC vs. Exchange arbitrage, where traders capitalize on temporary dislocations between private OTC quotes and live public market prices.

They do this by providing two-sided quotes and negotiating settlement terms on a case-by-case basis. This process gives institutional funds access to unique and often uncorrelated investment opportunities not found on public exchanges. The OTC market lets investors trade stocks, bonds, currencies, and other financial instruments not present on national exchanges. In these markets, there’s less regulation and fewer rules, which can be a good or bad thing. One of the big risks, though, is that OTC securities tend to be thinly traded.

Market Tiers

When used strategically, OTC offers unparalleled efficiency and access across global financial markets. Because they trade like most other stocks, you can buy and sell OTC stocks through most major online brokers. Swiss food and drink company Nestle (NSRGY +0.01%) is an example of a major company that trades OTC in the U.S.

This has made the OTC markets a breeding ground for pump-and-dump schemes and other frauds that have long kept the enforcement division of the U.S. But perhaps the greater risk to OTC equity investors is that there are fewer disclosure requirements for many unlisted companies. A company that’s listed on a U.S. exchange must follow disclosure rules that require it to file regular reports and financial statements with the U.S.

The over-the-counter market refers to securities trading that takes place outside of the major exchanges. There are more than 12,000 securities traded on the OTC market, including stocks, exchange-traded funds (ETFs), bonds, commodities and derivatives. In the U.S., the National Association of Securities Dealers (NASD), later the Financial Industry Regulatory Authority (FINRA), was established in 1939 to regulate the OTC market. Since the exchanges take in much of the legitimate investment capital, stocks listed on them have far greater liquidity. OTC securities, meanwhile, often have very low liquidity, which means just a few trades can change their prices fast, leading to significant volatility.

These securities represent ownership in the shares of a foreign company. They are issued by a U.S. depositary bank, providing U.S. investors with exposure to foreign companies without the need to directly purchase shares on a foreign exchange. OTC markets provide access to securities not listed on major exchanges, including shares of foreign companies.

Conclusion: A Tool for a Specific Purpose

In contrast, the major exchanges have centralized locations and use matching technology to process trades immediately. It also provides a real-time quotation service to market participants, known as OTC Link. OTC trading is the buying and selling of financial instruments outside of such an exchange.

An OTC trading transaction is typically a manual, high-touch process. It is built on negotiation and trust between two professional counterparties. With the maturation of the crypto market, institutional players are now heavily utilizing OTC desks to execute high-volume trades in Bitcoin, Ethereum, and a wide array of stablecoins. It includes instruments like Interest Rate Swaps (IRS) for managing rate exposure and Currency Forwards for locking in a future exchange rate. You’ll also find Credit Default Swaps (CDS), which act much like insurance against a potential default, alongside highly customized Exotic Options designed with non-standard payout features.