What is Over-the-Counter Market?

Over-the-Counter is the abbreviation of OTC. In trading terms, OTC implies trading via decentralized networks. Decentralized markets include is simply a market mesh comprising several tech devices. This mesh enables investors to develop a marketplace without a primary location. Two parties communicate with each other without any third party and carry out trading. This is how the OTC market works. We have an example of cryptocurrencies that that over-the-counter. If we talk about the opposite market, there comes forex which is not decentralized and is handled by companies or governments. 

An instance of OTC trading is security, currency, or other financial product that can be bought through a vendor, via telephone, or electronically. In most cases, business is normally operated by telephone, email, and reliable computer webs. The OTC market is organized through brokers and vendors who directly negotiate. A benefit of the OTC market is that non-standard amounts of stock can be exchanged.

With that, the OTC often entails lesser securities. Therefore, it comprises stocks that do not require to meet market capitalization regulations. OTC markets could also include firms that cannot maintain their product above a particular price per share, or who are in default filings. These types of firms are not able to market on a forex exchange but can do on the OTC markets.

Regardless, these are not the only firms that trade in OTC markets. There are large, established firms that generally tend to select an exchange to schedule and market their securities on. 

OTC Market

The over-the-counter market is a web of companies that operate as market builders for specific economical and low-traded stocks, for instance, penny stocks. There are two types of stocks: 

Listed Stocks that trade on an exchange. 

Unlisted Stocks that are traded over the counter markets. 

What Can You Trade on OTC Market? 

OTC Markets allow trades of various things. As I have told you earlier that unlisted stocks (such as OTCQX, OTCQB, and OTC Pink marketplaces)  are traded on an OTC. With that, the following is the list of stuff that can be traded on OTC: 

• Debt securities
• Financial instruments such as derivatives 
• Equities
• Particular instruments such as bonds 

Trading Mechanisms 

Trading mechanisms deduce the logistics behind trading possession and securities irrespective of the type of market that can be exchanges, dealers, or OTC markets. The mechanisms are the procedures by which buyers of a property are conformed with sellers. OTC trading has two following mechanisms: 

• Order Driven 

Using this mechanism, consumers and vendors of the assets are eligible to place an order that they wish to buy or sell. The lists can be made on the marketplace with the best price tag. Orders will take place until a suitable counterparty comes in line to either buyer or seller. 

• Quote Driven 

In this mechanism, the prices are continuously given to buyers or sellers. The prices are made by market makers which makes this machine more suitable for OTC markets. It functions like this: for the buyer, the price quoted is on which the seller is willing to sell, and for the seller, the price quoted is on which the buyer is willing to buy at. The quoted buying price is always less than the selling price. 

Benefits of OTC Markets 

For this reason that OTC is decentralized and other incentives, there comes many benefits of trading in OTC. They are as follows: 

• Free from exchange fees.
• Help companies and institutions in promoting equity and financial instruments. 
• There are two categories of this market. Customer market in which dealers trade with their clients and Inter-dealer market in which dealers trade with each other. The price dealer quotes depend on who he is interacting with. 

Risks of OTC Trading 

The OTC markets have encountered developments in recent years. This consequence in elevated liquidity and better knowledge. With that, electronic quotation and trading have modified and enriched the OTC market. 

Regardless, OTC markets are still depicted by several dangers that may be less widespread in traditional exchanges. 

The three major risks of OTC are as follows: 

• Regulations

Traders may, though, encounter supplementary danger when trading in OTC. While brokers and vendors performing in the US OTC markets are governed by the Financial Industry Regulatory Authority (FINRA), exchanges are accountable to more rigid and strict regulations than OTC markets. Less strict governance or regulation may lead to problems. 

• Transparency  

OTC rates are not published publicly until after the exchange is finished. Because of this, one trade can be performed between two parties via the OTC market without others being familiar with the price point of the deal. This absence of transparency can cause buyers to confront unfavorable conditions. That can sometimes be a great loss to the buyer if any fraud happens to him. 

If we compare exchange with OTC, this doesn’t happen there, and instead trading on an exchange takes place in a publicly transparent way. This can provide some investors enhanced verification and confidence in their investments. This is a great drawback to OTC markets. They must work on increasing transparency. 

• Volatility 

Last, but definitely not least, this factor with OTC stocks is that they can be relatively volatile and uncertain. They can also be liable to market manipulation, so risk management strategies are recommended to be applied when trading. A stop-loss rule will automatically shut down a position once it runs a specific number of points against the merchant. A threshold will shut down a position once it shifts a specific number of points in service of the vendor. 

For both types of rulings, vendors can establish triggers at predetermined rate phases so they can distinguish their profit and loss percentages in advance. This is a good strategy if applied by both vendors and this way the market manipulation can be reduced and safe trading may take place. 

Bottom Line 

Knowing the basic information and functions of the OTC market is important before you start trading. Hope you’ve got the best kernels of wisdom from this post. If so, then do apply them, research more, and start trading. That is.