What are OTC stocks? A complete guide to understanding over-the-counter trading stocks

When investors seek more investment opportunities, they often encounter a question: why are some companies not listed on major exchanges? The answer lies in the OTC stock market. OTC stocks not only provide financing channels for small and medium-sized enterprises and startups but also open up an investment world beyond traditional exchanges. This guide will give you a comprehensive understanding of what OTC stocks are, how they operate, and what to watch out for when investing.

What Are OTC Stocks — Basic Concepts You Need to Know

OTC stands for “Over The Counter,” also known as “off-exchange trading” or “over-the-counter trading,” meaning “over-the-counter buying and selling.” In simple terms, OTC stock trading occurs outside centralized markets — investors do not trade on formal stock exchanges but buy and sell directly through banks, brokers, phone, or electronic systems.

In the OTC market, prices are not determined by a collective bidding process like in a unified market but are negotiated directly between trading parties. Your trading counterpart could be a bank, securities firm, corporation, or other individual investors.

OTC stocks usually come from small to medium-sized companies that do not meet the listing standards of exchanges or are unwilling to comply with strict disclosure requirements. In recent years, with the development of the internet, the OTC market has rapidly expanded, attracting more and more investors.

OTC Stock Trading Mechanisms and Rules

In Taiwan, OTC stock trading methods are identical to those of listed stocks, but the company size and listing standards differ. The process includes the following steps:

Step 1: Placing Orders via Broker Investors submit buy or sell orders to their broker, similar to purchasing listed stocks.

Step 2: Orders Enter Matching System Brokers upload orders to the Taiwan OTC Center’s Automated Trading System (ATS), which automatically matches trades based on “price priority, time priority.” The technical trading rules are synchronized with the listed market, requiring no additional steps.

OTC Stock Trading Hours and Rules

Core Trading Rules:

• Call auction mechanism: every 5 seconds
• Price fluctuation limit: ±10% (same as listed markets)
• Matching method: centralized matching
• Settlement cycle: T+2 (settlement two business days after trade)

These mechanisms are fully aligned with the listed market, which is why the threshold for investing in OTC stocks is relatively low. Additionally, OTC listed companies are required to comply with disclosure regulations, including quarterly and annual reports and major news announcements, making them more transparent than the emerging OTC market.

Understanding Taiwan’s OTC Stock Market

Taiwan’s stock market is divided into two main systems: the “Securities Exchange” and the “OTC Center.” The index compiled by the OTC Center is called the “OTC Index” or “Goumai Index,” reflecting the state of Taiwan’s over-the-counter stock market. Many investors observe the OTC Index to gauge the trend of small and medium-sized stocks.

Why Are There Two Markets?

The government established the OTC Center to balance market development. Strict listing standards can hinder many promising startups — these companies may have revolutionary ideas but lack funding to start, leaving their innovations on paper.

Therefore, the government relaxed OTC listing conditions: companies with at least two supporting brokerage firms’ recommendations can be listed for trading. If a company performs well within six months (e.g., turns profitable or shows significant improvement), it can apply for transfer to a formal exchange or OTC listing.

Market Risks to Consider

Due to the relatively lenient application criteria, besides genuine innovative startups, there are inevitably some less reputable companies entering the market. Some speculators or unscrupulous brokers may promote high-risk stocks to manipulate and profit from retail investors. Therefore, investors should carefully select targets and choose reputable brokers to ensure safe trading.

Comparing OTC Stocks and On-Exchange Stocks

The emergence of on-exchange trading was to establish “standards,” so compared to the more regulated on-exchange trading, OTC trading is closer to the original economic supply and demand principles. The main differences are:

Product Specification Differences For example, in gold trading, on-exchange trading is like going to a bank — each has standard specifications; OTC stocks are like visiting pawnshops — each has different conditions. However, pawnshops can trade a wider variety of goods, which is an advantage they hold.

Impact of Trading Modes On-exchange trading uses call auctions, characterized by transparency and fairness but with less profit margin. OTC trading is negotiated, where buyers and sellers agree on a price for immediate transaction. Because it’s not public, even if someone offers a higher price, it’s not guaranteed to be accepted — in OTC stocks, information is more valuable than capital.

Regulation and Security On-exchange trading is approved and fully regulated by the government, while OTC stocks are traded by brokers with only partial regulation. Many fraudsters exploit regulatory loopholes to set up fake exchanges for scams. Investors must choose platforms authorized and regulated by the government to ensure safety.

Opportunities and Risks of Investing in OTC Stocks

Advantages of OTC Stock Investment:

✓ Broader Investment Options — OTC stocks give access to investment forms unavailable on traditional exchanges, including derivatives, CFDs, forex, and unlisted stocks, offering a wide range of markets.

✓ More Flexible Trading — OTC stocks have more flexible trading methods and product specifications, allowing investors to tailor strategies according to their goals without the strict constraints of on-exchange trading.

✓ Leverage Flexibility — Traditional on-exchange markets offer limited leverage, but OTC stocks provide various leverage options, enabling investors to amplify gains with higher leverage.

✓ Gradually Improving Security — Modern OTC markets have established multiple security mechanisms similar to centralized markets. Many brokers, authorized and regulated by reputable financial institutions, offer more professional services.

Risks of Investing in OTC Stocks:

✗ Relatively Lax Regulation — OTC markets lack unified rules and full transparency, with looser legal oversight, leading to potential scams by fraudulent brokers. This contrasts with listed companies that must comply with strict regulations.

✗ Potential Low Liquidity — OTC stocks tend to have lower liquidity than centralized exchanges, meaning you might not be able to execute trades at desired prices or face difficulties buying or selling.

✗ Market Volatility Risks — Like stocks, OTC stocks are affected by market fluctuations. Most OTC investors lack access to transparent market information, making them vulnerable to information asymmetry.

✗ Counterparty Risk — Since trades are negotiated, there is a credit risk with the counterparty. Some products with high volatility and low liquidity carry higher risks.

How to Safely Invest in OTC Stocks

To ensure safe OTC stock investments, focus on the following:

First: Choose a Reputable Broker This is the most important step. The broker should be regulated by different authorities and have strong risk management. Check if the broker holds government-approved licenses (e.g., ASIC in Australia, CIMA in Cayman, FSC in Mauritius).

Second: Select Established Trading Products Prioritize products with a long trading history and relatively good liquidity, such as forex. Fully understand details like spreads, liquidity, withdrawal procedures, and conduct comprehensive assessments.

Third: Use Investor Protection Measures Legitimate OTC trading platforms usually offer risk assessments, KYC procedures, complaint mechanisms, and other investor protections to reduce risks.

Investment Checklist:

• ✓ Is the broker regulated by multiple countries?
• ✓ Does the company disclose clear risk warnings?
• ✓ Are client funds segregated?
• ✓ Are customer service and complaint channels well-established?
• ✓ How is the liquidity of traded products?
• ✓ Are spreads and fee structures transparent?

By following these steps, ordinary investors can find relatively safe trading opportunities in the OTC market and effectively reduce investment risks.