Over-the-Counter (OTC) Trading

Understanding Over-the-Counter (OTC) Trading

To comprehend over-the-counter (OTC) trading, it’s crucial to grasp what over-the-counter means in the first place.

The term ‘over-the-counter’ describes how securities are transacted via a broker-dealer network rather than through a centralized exchange.

OTC trading involves various instruments, such as equities, debt instruments, and derivatives, which are financial contracts deriving their value from an underlying asset, like a commodity.

In certain instances, securities may not meet the standards necessary for listing on a conventional market exchange, which can be traded over-the-counter.

Exploring Decentralization

In the realm of trading, over-the-counter trading refers to transactions conducted via a decentralized dealer network.

A decentralized market is a structure composed of various technological devices, enabling investors to form a marketplace without needing a physical central location.

Thus, the antithesis of OTC trading is exchange trading, which occurs via a centralized exchange.

Enabling Access for Small Securities

Smaller securities exemplify over-the-counter trading as these stocks do not require meeting market capitalization requirements.

OTC markets can also accommodate companies unable to maintain their stock price above a specific threshold or companies undergoing bankruptcy proceedings.

Unable to trade on an exchange, such companies can find a trading platform in over-the-counter markets.

An Insight into Privacy and Price Transparency

It’s important to note that over-the-counter trades come with associated risks: investors may face heightened risk when trading over-the-counter.

Moreover, OTC prices are not publicly disclosed until the trade has been finalized.

As a result, a transaction can be executed between two parties via an OTC market without others knowing the price at the time of the transaction.