Understanding OTC: The Complete Investment Guide to Over-the-Counter Trading

When you discover a promising company but can’t find it on mainstream exchanges, what should you do? The answer lies in OTC over-the-counter trading. What is OTC? Simply put, it’s a trading method conducted outside of formal exchanges. Compared to centralized exchanges, OTC offers a wider variety of products, more flexible trading rules, and higher customization possibilities. But it also comes with higher market risks. This article will guide you through the core mechanisms of OTC trading, compare its advantages and disadvantages, and explain how to participate safely.

Definition and Basic Concepts of OTC Over-the-Counter Trading

OTC stands for Over The Counter, referring to a trading method where investors buy and sell various assets directly through decentralized channels such as banks, brokerages, phone, or electronic systems, rather than through centralized markets like stock exchanges. This market is also called “over-the-counter trading,” “desk trading,” or “OTC market.”

The biggest feature of OTC trading is: Prices are negotiated directly between buyer and seller, not determined by a unified bidding process. This means the same asset can have completely different transaction prices depending on the counterparty. The counterparties are highly diverse, including banks, securities firms, corporations, individual investors, and various financial institutions.

Many companies that do not qualify for listing on mainstream exchanges—such as small and medium enterprises or startups—choose to raise funds and trade on OTC markets. Some companies that meet listing requirements may also deliberately avoid going public to evade the disclosure pressures that come with being listed. Because OTC markets operate under relatively loose rules and flexible regulation, with a broader range of products and high customization, and with the development of internet technology, OTC trading has rapidly expanded into a significant global investment channel.

However, it’s important to note that compared to on-exchange trading, OTC prices are less transparent. Due to the lack of strict trading rules, disclosure requirements, and unified regulation, both parties face higher credit and market risks.

What Products Can Be Traded in OTC Markets?

OTC trading covers a much broader range of products than on-exchange trading. Besides traditional stocks and bonds, it includes various derivatives. Common OTC assets include:

Stocks: The OTC stock market is its largest segment. Unlike listed stocks, OTC stocks include unlisted or non-listed small and medium enterprises and startups, providing vital financing channels for growth companies.

Bonds: Due to their large issuance volume, diverse types, and infrequent trading, bonds are often more actively traded OTC than on exchanges. Investors can access a wider variety of issuers and bond types.

Derivatives: Options, futures, CFDs (contracts for difference), and other derivatives can be traded OTC, offering more leverage and risk management tools.

Foreign Exchange (Forex): Currency trading platforms operate OTC, with huge trading volumes and liquidity.

Cryptocurrencies: Popular digital assets can be traded in OTC markets in bulk, allowing investors to purchase large quantities of digital assets at once—something difficult to do in dedicated crypto exchanges.

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 trading process includes:

Step 1: Investors place orders through brokerages, with trading methods identical to those for listed stocks.

Step 2: Brokerages upload orders to the OTC Centralized Automated Trading System (ATS). The system matches buy and sell orders based on “price priority, time priority,” executing trades accordingly. The technical rules are fully synchronized with the listed market, requiring no extra steps from investors.

Trading Rules Consistency: Taiwan’s OTC and listed markets follow the same rules—price limits (±10%), call auctions, order matching, and daily trading hours. Call auctions occur every 5 seconds. Settlement is T+2 (trade date plus two working days), same as for listed stocks.

Information Disclosure: OTC companies must comply with disclosure regulations, including quarterly and annual reports and major news, making their transparency higher than that of OTC unlisted companies. Investors can access sufficient information.

Overall, Taiwan’s OTC market mainly serves small and medium-sized, growth-oriented companies. Although more volatile, it offers attractive growth potential. Since liquidity is better than in the unlisted market and the system is similar to that of listed companies, the entry barrier for retail investors is relatively low. However, due to smaller company size, stock prices may be more susceptible to news and market sentiment, so investors should pay close attention to volatility risks.

Comparing On-Exchange and OTC Trading: Seven Key Dimensions

The emergence of centralized exchanges aimed to establish standardized trading rules. Compared to the strict regulations of on-exchange trading, OTC trading is closer to the fundamental supply-and-demand principles of economics. There are significant differences across multiple dimensions:

Product Standardization: On-exchange products are highly standardized—e.g., gold trading on a bank’s platform has uniform standards; OTC is like pawnshops, where each shop’s offerings differ. Pawnshops can trade a wider variety of goods than banks.

Trading Mode: On-exchange uses call auctions, characterized by transparency and fairness but limited profit margins. OTC involves negotiated deals, where buyers and sellers agree on prices. Due to less transparency, information advantage is crucial.

Product Types: On-exchange trading mainly involves standardized securities and futures; OTC offers a broader array, including forex CFDs, cryptocurrencies, and unlisted stocks. Standardization limits product variety on exchanges, while OTC markets are highly diverse.

Platform and Regulation: Exchanges are government-approved and strictly regulated; OTC markets are operated by broker-dealers with lighter oversight. Investors should choose licensed and regulated platforms.

Price Transparency: Exchanges publish all transaction prices and volumes; OTC markets lack mandatory disclosure, leading to information asymmetry. Skilled traders can profit from this, while unskilled investors risk losses.

Liquidity and Trading Volume: Exchanges have large trading volumes and high liquidity, attracting international capital; OTC volumes are smaller, with lower liquidity.

Trading Methods: Exchanges enforce strict risk controls, limiting leverage and short-selling; OTC offers more flexibility, higher leverage, and diverse investment strategies.

Opportunities and Risks in OTC Trading

✔ More Investment Options: OTC markets enable access to derivatives, binary options, CFDs, forex, and more, broadening investment choices.

✔ Greater Flexibility: Trading methods and product specifications are more adaptable, allowing tailored investment strategies.

✔ Higher Leverage: Unlike traditional markets with limited leverage, OTC offers various high-leverage options to amplify gains.

✔ Enhanced Security Measures: Modern OTC markets have improved safety mechanisms, similar to centralized markets. Regulated brokers under licensed financial institutions are more professional.

❌ Lack of Unified Regulation: OTC markets lack comprehensive regulation, making them prone to fraud by unscrupulous brokers. Compared to listed companies, many OTC firms have weaker compliance.

❌ Liquidity Risks: OTC securities often have lower liquidity than exchange-traded assets, potentially leading to difficulty executing trades at desired prices.

❌ Market and Information Risks: Due to limited transparency, OTC investors face market volatility and information asymmetry. Some malicious actors may spread false information to deceive investors.

❌ Counterparty Credit Risk: The absence of strict rules and disclosure requirements means investors bear the risk of counterparty default. Certain assets with high volatility and low liquidity pose greater risks.

How to Trade OTC Safely? Investor Guidelines

OTC trading isn’t inherently unsafe, but it carries higher risks than centralized exchange trading. The key is how investors can mitigate these risks.

Step 1: Choose a Reliable Broker. Opt for platforms with multiple regulatory licenses. A secure broker should be regulated by reputable authorities (e.g., ASIC, CIMA, FSC) and have strong risk management systems.

Step 2: Focus on Mature Products. Prioritize liquid, low-spread, high-volume assets like forex. Understand their spreads, liquidity, withdrawal processes, and overall market conditions.

Step 3: Use Platform’s Investor Protection Features. Reputable OTC platforms offer risk assessment tools, KYC procedures, complaint mechanisms, etc., to reduce risks.

Step 4: Learn Basic Knowledge and Risk Management. Before trading OTC, investors should understand relevant concepts and use tools like limit orders, stop-loss, and negative balance protection. Develop clear strategies.

Step 5: Start Small. Practice with demo accounts, get familiar with the platform, then gradually invest real funds, beginning with small amounts.

OTC markets open doors to diverse investment opportunities but also demand caution. Choosing regulated, trustworthy OTC platforms is essential to protect your investments.