OTC, or over-the-counter trading, provides chances like the affordable purchase of a new, high-potential company.
In this method, financial instruments like as stocks, bonds, and other securities are exchanged directly between two parties as opposed to on a stock exchange for the general public like the New York Stock Exchange (NYSE) or Nasdaq.
Michael Bertov, the author of The Evergreen Startup, adds that OTC gives you access to high-growth growing businesses, especially startups.
Additionally, as OTC investments often cost less than their public market counterparts, you receive more investment for your money.
What does OTC mean?
They are referred to as dealer markets or networks. Stock exchanges, in contrast, are auction marketplaces. Investors submit offers for stocks after an asking price (the “ask”) is posted, competing with one another.
This indicates that although its stock can be purchased and traded publicly, it is not listed on a significant exchange like the NYSE or Nasdaq. Therefore, these equities are bound by the guidelines and standards set by these exchanges for the listed corporations.
In fact, SEC rules were revised in September 2020 to improve disclosure and investor safety by requiring broker-dealers to refrain from publishing price quotes for a security when up-to-date information about that security is not immediately accessible to the general public.
OTC trading is also typically conducted through a registered broker-dealer. The Financial Industry Regulatory Authority (FINRA) oversees broker-dealers.
What kinds of investments trade OTC?
Since they don’t trade enough shares or their shares don’t sell over a minimum price, many small-company equities that are listed on major exchanges are OTC securities. They trade for less than $5 per share and are frequently referred to as penny stocks.
Other OTC companies are bigger, but they are unable to pay the listing fees that the major exchanges want (or don’t want to). For instance, organisations that meet the requirements can pay up to $167,000 to list on NASDAQ.
In addition to equities and bonds, investments that trade OTC frequently consist of:
- Private agreements between two parties known as derivatives are frequently arranged by brokers. These can include forwards, futures, options, or other contracts whose value is determined by the value of an underlying asset, such as a stock.
- international money. Every day, the Forex, an over-the-counter currency market, trades more than $6.6 trillion in currencies from various countries.
- digital money, such as bitcoin and ethereum.
What are the major OTC markets?
OTC Markets Group is a significant over-the-counter (OTC) network. Depending on your broker, you as an investor will have access to this market. The Grey Market is another option, which we’ll discuss below.
OTC Markets Group
According to their size, share price, and frequency of financial reporting and transparency, over-the-counter equities are categorised into three categories by OTC Markets.
The following is the OTCQB® Venture Market, which is for start-up or growing enterprises and requires a minimum bid price of $0.01.
This category contains shell companies, overseas businesses, penny stocks, and other enterprises that opt not to publish their financial data.
Grey Market
The term “grey market,” sometimes known as “other OTC,” refers to any security that is traded over-the-counter but is not quoted by broker-dealers for a variety of reasons, including a lack of investor interest, a lack of financial information, or a failure to comply with regulatory requirements.
Is it safe to buy OTC stocks?
OTC trading has had a shady reputation. Partly that’s because of the basic way it operates. OTC is a secret negotiation between a buyer and a seller, in contrast to the complete transparency of stock exchanges, where prices are made public.
It is not surprising that OTC markets have been the scene of fraud and illegal activity. Dealing in penny stocks allows for illicit pump and dump schemes, in which a stock is promoted (pumped up).
They genuinely run like “discount” stock exchanges, enforcing regulations, exercising monitoring, and, in the case of OTC Markets, categorising equities according to tiers.
Risks of OTC trading
Aside from fraudulent activity, OTC trading is also fraught with dangers.
- Lack of price transparency. As mentioned above, a vendor might hypothetically charge one customer one amount for a security and name a different price to another.
- Low liquidity. There isn’t much demand because many OTC equities are barely traded. This makes it challenging to sell them when you want to.
- Volatility. OTC securities have a lower trading volume, which could cause sudden price changes.