Over-the-Counter (OTC) trading stands for any process that involves securities being traded via broker-dealer networks instead of on a centralized exchange. OTC can include many types of trading such as debt instruments, equities, or commodity derivatives, where the financial contract's value is gotten from underlying assets, which are physical commodities.
Over-the-counter trading is typically carried out for securities that fail to meet the requirements for being listed on standard stock exchanges like the New York Stock Exchange. It is important to note that equities listed on exchanges can also be traded over the counter, as stocks that are not listed on exchanges. Whenever the latter get traded via OTC, they are referred to as OTC equities (or over-the-counter equity securities).
For the most part, OTC trading is done by companies whose stocks are unable to meet the listing requirements of standard stock exchanges. That's not to say that other types of securities and equities cannot trade over the counter. They can, and they do. Any stock that is traded over the counter is referred to as an unlisted stock, while stocks traded on centralized exchanges are known as listed stocks.
Over the Counter Bulletin Board (OTCBB) and Pink Sheet listing services are two services through which OTC trade transactions can be carried out. The OTCBB is an electronic quotation and trading medium delivered to subscribing members by the Financial Industry Regulatory Authority (FINRA), the agency in charge of creating and implementing rules regulating brokers and broker-dealers.
The OTCBB contains useful volume information for OTC securities, and brokers subscribed to the system can use it to enter quotes and negotiate with other broker-dealers over computer networks. Pink sheet listings include traded OTC stocks; they are primarily small-company penny stocks not listed on formal stock exchanges. Dealers make use of the OTCBB and Pink Sheet to provide liquidity in the market.
OTC trading isn't only limited to small companies. There are wider-known, more prominent companies that hold listings on OTC markets. Some of these companies, including Allianz SE, Roche Holding Ag, Nestle SA, and Bayer A.G, are foreign and already listed on a formal international exchange but still trade shares on the OTCQX.
Financial instruments such as bonds and derivatives are considered OTC securities. They are not traded on formal exchanges because banks try to avoid the cost of exchange listing fees. Instead, they are issued by the banks and marketed via broker-dealer networks. It is typically carried out by meeting client buys and sells either in-house or from external brokerage firms.
The OTC Markets Group is the largest trading network group, and it operates three popular networks: OTC Pink, the Venture Market (OTCQB), and the Best Market (OTCQX). These networks are provided for companies not big enough to qualify for listing on the standard stock exchanges.
OTC networks are not formally centralized exchanges like the NYSE or Nasdaq, but eligibility requirements still govern them. The OTCQX, for instance, is the highest tier network in the OTC Market Group, and companies listed on it go through strict evaluations. These companies have greater liquidity and larger market caps than companies listed on the other networks.
The OTC marketplace consists of stock listings of small and developing companies, some of which also submit reports to the Securities and Exchange Commission regulatory body.
Pink Sheet stocks are also listed on the OTC networks, and they come in a wide variety. Shares of this sort typically come with reduced transaction costs, but they are also plagued with price falsification and fraud issues. They do not meet SEC requirements and, as such, are not required to file statements with the commission.
The OTC marketplace is a great platform to trade bonds, derivatives, and American Depository Receipts (ADRs). Still, when it comes to speculative OTC securities, investors are advised to take great caution. It might be difficult to find valuable information, including business financials, and this difficulty is heightened by the fact that filing requirements differ between OTC listing platforms.
More often than not, financial advisors will categorize OTC trading stocks as a speculative activity, making it essential for investors to critically consider the investment risk that comes with its inclusion in their portfolio. It must be said, however, that these stocks also come with the potential for huge returns. OTC shares trade at lower prices and with reduced transactional fees, making it very easy for their prices to undergo appreciation.
One potential downside to trading OTC is that OTC marketplaces typically have shares with low trade volumes, meaning that it might take longer to find ready buyers for them. There is also a more significant gap between bidding prices and asking prices.
OTC networks are essential alternatives for small companies that do not meet standard exchange listing requirements and other companies who simply do not want to go through the extensive process and costs of formal exchange listings.
In summary, the pros of OTC include:
Cons of trading OTC include:
Quantix Capital provides extensive information on trading, including courses and trading expert resources and advice on OTC Markets. You can find more information on Quantrix Capital's website at QuantrixCapital.com. The website also contains a list of the companies that are most actively traded.
Regular trading days could see the total dollar volume exceed $1.2bn, including over 6 billion shares getting traded. Some of the more popular companies listed on OTC markets include healthcare company Bayer A.G, multimedia giant Tencent Holdings LTD, and beverage company Nestle SA.