Understanding the OTC Market: How Over-the-Counter Trading is Changing the Investment Landscape

What is the OTC Market

When investors want to purchase shares of companies that are not available on mainstream exchanges, the OTC market (Over The Counter) comes into play. The OTC market refers to a trading method where investors do not trade on centralized exchanges but buy and sell securities directly through dispersed channels such as banks, brokerages, and electronic systems.

The core feature of the OTC market is direct negotiation of prices between trading parties. Unlike the unified public quotes on centralized exchanges, in OTC trading, buyers and sellers can be banks, securities firms, corporations, or individual investors who negotiate prices flexibly based on market conditions. Because of this, the OTC market is also called the “Over-the-Counter,” “OTC trading,” or “Pink Sheets.”

The Role of the OTC Market in the Global Financial Ecosystem

Many companies do not meet the listing requirements of exchanges, but that does not mean they lack investment value. Startups, small and medium-sized enterprises, and even some companies qualified for listing but choosing to stay low-profile for competitive reasons often opt for OTC financing and trading. With the development of the internet, the OTC market has rapidly expanded, becoming an important trading channel for global investors.

However, compared to on-exchange trading, OTC markets have obvious disadvantages: lack of unified regulation, lower price transparency, and relaxed information disclosure requirements, which imply higher trading risks. Participants need to directly bear counterparty credit risk.

Types of Products Traded in the OTC Market

OTC products are diverse and far richer than the standardized securities on exchanges:

Stocks: Including unlisted company shares, startup company stocks, and small to medium-sized stocks traded over-the-counter due to not meeting listing criteria. This is the largest investment market within OTC trading.

Bonds: OTC markets are more suitable for bond trading because of the large issuance volume, variety, and infrequent trading, making centralized exchanges less capable of meeting the diverse needs of these products.

Derivatives: Contracts such as options, futures, and spread contracts are all applicable in OTC markets.

Foreign Exchange and Cryptocurrencies: Various currency trades and popular cryptocurrencies can be conducted in OTC markets. Especially, OTC crypto markets enable large one-time purchases of assets, which are difficult to achieve on dedicated crypto exchanges.

How the OTC Market Operates

Taking Taiwan’s OTC market as an example, the entire trading system operates similarly to on-exchange markets but with different company sizes and listing standards.

Step 1: Investors place orders through brokerages; the process of buying OTC stocks is exactly the same as buying listed stocks.

Step 2: Orders are uploaded to the OTC Center’s Automated Trading System (ATS). The system automatically matches trades based on “price priority, time priority,” with technical rules synchronized with those of listed markets.

Trading hours and rules:

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

Key features: The OTC market has price limits, call auction mechanisms, matching trading systems, and daily trading time restrictions. Settlement follows T+2, identical to listed stocks.

OTC Market vs. On-Exchange Trading: A Deep Comparison

Product Specification Differences

On-exchange products are standardized—like exchanging currency at a bank, with uniform specifications across branches. In contrast, OTC products are non-standardized—like pawning appraisals, with each situation unique. However, OTC trading offers a wider variety of products.

Trading Mode Differences

On-exchange trading: Uses a call auction model, transparent and relatively fair, but profit margins are limited.

OTC market: Negotiated trading, where buyers and sellers agree on a price to complete the transaction. Since trades are not public, the same asset may have different prices, making information more important than capital.

Regulation and Transparency

On-exchange markets are approved by the government and strictly regulated, with prices and volumes publicly available. OTC markets are operated by general brokerages with relatively loose regulation; trading details are not necessarily disclosed, creating opportunities for informed traders to earn excess returns but also posing risks of excessive losses for ordinary investors.

Trading Volume and Liquidity

On-exchange trading involves large volumes and high liquidity, making it easier for international funds to enter. OTC markets have smaller trading volumes and lower liquidity, making it more difficult to obtain favorable prices.

Trading Methods and Leverage

On-exchange trading methods are limited with strict risk controls, and leverage and short-selling are heavily restricted. OTC markets offer more flexible trading options, with fewer leverage restrictions, allowing investors to employ more advanced strategies.

The Unique Position of Taiwan’s OTC Stocks and OTC Center

Taiwan’s stock market is divided into the “Stock Exchange” and the “OTC Center.” The OTC Index (Gretai Index) compiled by the OTC Center reflects the status of Taiwan’s over-the-counter stock market and is an important reference for investors assessing small and medium-sized stocks.

The government established the OTC Center to solve a paradox: overly strict listing standards hinder startup development, but complete laissez-faire could lead to market chaos. Therefore, the OTC Center adopts a compromise—companies with at least two broker recommendations can enter. If their performance improves significantly within six months, they can apply for listing or OTC transfer.

However, due to relatively low thresholds, the OTC market has also become a hotbed for speculation. Some unscrupulous brokers recommend high-risk stocks for quick profits, known as “Pink Stocks.” Therefore, investing in OTC markets requires careful stock selection and finding reputable brokers.

Advantages of the OTC Market

✓ Broader Investment Options: OTC markets help investors access derivatives, binary options, contracts for difference (CFDs), forex trading, and other investment forms.

✓ More Flexible Trading: Product specifications and trading methods are more adaptable, allowing tailored strategies based on individual investment goals.

✓ Greater Leverage Flexibility: Traditional markets have leverage restrictions, but OTC markets offer multiple leverage options, enabling higher leverage to amplify returns.

✓ Enhanced Security: Modern OTC markets have been optimized and improved; many brokers are authorized and regulated by reputable financial institutions, making trading relatively safer for knowledgeable investors.

Risks and Challenges of the OTC Market

❌ Lack of Regulation: OTC markets lack unified regulations, with looser legal oversight. Many companies that do not meet exchange requirements can only trade OTC, leading to frequent fraud by unscrupulous brokers.

❌ Insufficient Liquidity: OTC securities have lower liquidity than centralized exchanges, and transactions may not be executed at ideal prices.

❌ Market Volatility Risks: OTC markets are affected by market fluctuations, and most investors cannot access the same level of transparent information as on centralized exchanges.

❌ Counterparty Credit Risk: Since prices are negotiated, sellers may quote different prices to different buyers, exposing buyers to higher credit risk.

❌ False Information Risks: There are cases where malicious actors spread false information to deceive investors.

Is OTC Over-the-Counter Trading Safe?

OTC markets are not entirely unsafe, but they do carry risks compared to centralized exchange trading. The key lies in how investors respond.

First, ensure your broker is safe and reliable. Choosing platforms under multiple layers of regulation with strong risk controls is crucial. Legitimate platforms offer investor protection measures such as risk assessments, KYC procedures, and complaint mechanisms.

Second, select mature and stable trading instruments. Understand spreads, liquidity levels, withdrawal ease, and other comprehensive information.

Third, actively manage risks. In OTC markets, information access and judgment are vital. Investors need continuous learning, vigilance against false information, and careful assessment of counterparty creditworthiness.

In summary, the OTC market is an indispensable part of the financial system. It provides financing channels for high-quality companies that cannot list and offers investors diverse investment opportunities. However, participants must recognize its risk characteristics, choose legitimate platforms, acquire sufficient knowledge, and perform thorough risk assessments to achieve better investment experiences in OTC trading.