Over-the-Counter (OTC) Trading

What Is Over-the-Counter (OTC) Trading?

To understand over-the-counter (OTC) trading, you’ll first need to understand what over-the-counter actually means. Over-the-counter refers to the process of how securities are traded through a broker-dealer network as opposed to a centralized exchange. Over-the-counter trading involves equities, debt instruments as well as derivatives that are financial contracts an can derive their value from an underlying asset, an example being a commodity.

There are specific cases as well where the securities might not meet the requirements to have a listing on standard market exchange and these can be traded over-the-counter.

Now, in trading terms, over-the-counter trading is the process of trading through a decentralized dealer network. A decentralized market is a market that is structured to consist of various technical devices, and this structure is what allows investors to create a marketplace without a central location. As such, the opposite of OTC trading is exchange trading, and this takes place through a centralized exchange.

An example of over-the-counter trading would be smaller securities, as they consists of stocks that do not need to meet market capitalization requirements. Over-the-counter markets can also involve companies that cannot keep their stock above a certain price per share or ones that are in bankruptcy filings. These types of companies are not able to trade on an exchange, but can trade on over-the-counter markets. 

Over-the-counter trades have risks associated with them: investors can experience additional risk when trading over-the-counter. Furthermore, OTC prices are not disclosed publicly until after the trade is complete, and as such, a trade can be executed between two parties through an OTC market without others being aware of the price at the point of the transaction.