Complete Guide to OTC Over-the-Counter Trading: From Market Structure to Investment Options

When you discover a promising company that can’t be found on mainstream exchanges, OTC (Over The Counter) trading can be a potential alternative. OTC markets not only offer broader investment opportunities but also attract more investors due to their flexible trading mechanisms. This article will explore how OTC trading works, market characteristics, and how investors can participate safely.

What is OTC Trading? An Introduction to Market Basics

OTC stands for Over The Counter, referring to transactions where investors buy and sell securities or other products outside centralized markets like stock exchanges, through dispersed banks, brokers, phone, and electronic systems. This market is also called “over-the-counter” or “over-the-counter trading.”

Unlike centralized markets with uniform bidding, OTC prices are negotiated directly between parties. The counterparties are diverse, including banks, securities firms, corporations, or individual investors. Many companies traded OTC do not meet exchange listing requirements, often small to medium-sized or startup firms. Some companies qualify for listing but choose OTC to avoid extensive disclosure obligations.

With the development of the internet and the expansion of international financial markets, OTC markets have grown rapidly. Investors’ demand for trading convenience and accessibility drives this trend. Compared to on-exchange trading, OTC markets are less regulated, with more flexible rules, but offer lower price transparency and higher risks, including counterparty credit risk.

What Can Be Traded OTC? Exploring Product Diversity

OTC markets feature a much wider range of products than centralized exchanges. Besides stocks and bonds, derivatives are a key characteristic of OTC markets.

Stocks remain the largest OTC investment market. Unlike listed stocks, OTC stocks include those of small and startup companies that do not meet listing criteria or have not applied for listing.

Bonds are particularly advantageous OTC. Due to large issuance volumes, diverse types, and infrequent trading, OTC’s flexibility makes it an ideal venue for bond trading.

Derivatives such as options, futures, and CFDs are also traded OTC, providing more risk management tools.

Foreign exchange (Forex) trading occurs on various platforms, most of which are OTC.

Cryptocurrencies can also be bought or sold in large amounts OTC, which might be difficult to achieve on dedicated crypto markets.

How Does OTC Trading Work? Analyzing the Mechanism in Taiwan

In Taiwan, OTC markets operate similarly to listed markets, mainly differing in company size and listing standards. The process includes:

Step 1: Investors place orders through brokers. Buying or selling OTC stocks follows the same process as on the exchange, with no special procedures.

Step 2: The order is sent to the OTC clearing system. When investors submit buy or sell orders, brokers upload these to the OTC’s automated matching system (ATS), which pairs orders based on price and time priority. The entire process and rules are synchronized with the exchange market.

Trading hours and rules:

• Pre-market: 08:30–09:00
• Regular trading: 09:00–13:30
• After-hours pricing: 13:40–14:30
• Call auction: every 5 seconds
• Price limits: ±10% (same as listed stocks)

OTC trading rules mirror those of the exchange, including price limits, call auctions, and daily trading hours. Companies listed OTC must comply with disclosure regulations, releasing quarterly, annual, and major news, making OTC more transparent than the Emerging Stock Market (興櫃). Investors can access sufficient information. Settlement follows T+2, identical to listed stocks.

Overall, OTC markets mainly involve small to medium-sized, growth-oriented companies with higher volatility but more thematic and growth potential. Liquidity is better than in the Emerging Stock Market and the same as the main exchange, so the entry barrier for retail investors is relatively low. However, due to smaller company size, stock prices are more susceptible to news and market sentiment, requiring cautious risk management.

On-Exchange vs. Off-Exchange: Seven Key Differences

To understand OTC’s positioning, compare it systematically with on-exchange trading:

Product Standardization: On-exchange products are standardized, like bank gold trading with uniform standards. OTC products are non-standardized, similar to pawnshops—each deal unique, but with a broader range of products.

Trading Mode: On-exchange uses transparent call auctions, while OTC involves negotiated prices, emphasizing information and bargaining.

Product Range: Exchanges mainly trade securities and futures due to standardization. OTC offers a wide array, including forex, cryptocurrencies, and unlisted stocks.

Regulation & Platforms: Exchanges are government-approved and strictly regulated. OTC is operated by brokers with less regulation, increasing risks of fraud or unlicensed platforms.

Transparency: Exchanges disclose prices and volumes; OTC may not. Lack of mandatory disclosure can lead to arbitrage opportunities for insiders and risks for uninformed investors.

Liquidity & Volume: Exchanges have high liquidity; OTC is less liquid, making it harder to execute large trades at favorable prices.

Trading Methods: Exchanges have strict controls; OTC offers more flexibility, including leverage and short-selling.

Opportunities and Risks in OTC Trading: What Investors Must Know

Advantages: OTC provides access to more products like derivatives, binary options, and CFDs. Trading is flexible, customizable, and offers higher leverage, amplifying potential gains. As the market matures, reputable brokers under proper regulation enhance safety.

Risks: OTC is not a formal exchange; lacks unified rules. No central oversight means higher risks:

• Lack of regulation: Less oversight, potential for fraud. Listed companies must follow strict rules; OTC companies may not.
• Lower liquidity: Difficult to buy/sell large amounts at good prices.
• Market risk: Less transparency can lead to sudden price swings.
• Counterparty risk: Fraudulent actors may use false info to deceive investors.

How to Participate Safely in OTC Trading? A Guide

While OTC trading isn’t inherently unsafe, it carries more risks than exchange trading. Investors should take proactive steps:

1. Choose reputable brokers: Ensure they are regulated by authorities like ASIC (Australia), CIMA (Cayman), FSC (Mauritius), etc. Verify licenses.

2. Select mature products: Understand spreads, liquidity, and market depth for forex and other established instruments. Be cautious with new or obscure products.

3. Use platforms with investor protections: Reputable platforms often have risk assessments, KYC procedures, complaint mechanisms, and client protection measures.

4. Enhance your knowledge: Learn basic trading principles, product features, leverage risks, and market dynamics to avoid blind investments.

5. Beware of scams: Avoid platforms promising unrealistically high returns. Legitimate OTC providers disclose risks transparently.

By making informed choices and selecting regulated, trustworthy platforms, investors can explore OTC markets while managing risks effectively. Continuous learning and vigilance are key to safe participation.