## Understanding Over-the-Counter (OTC) Trading: What It Is and How It Works

**What is OTC?** This is a common question among many investors. OTC stands for Over The Counter, referring to transactions where buyers and sellers do not trade on centralized exchanges but instead negotiate directly through broker-dealers, banks, electronic systems, and other decentralized channels. In simple terms, OTC is "over-the-counter trading" or "off-exchange trading," serving as an alternative investment arena outside of traditional exchanges.

OTC prices are not generated through centralized bidding processes like in major markets; instead, they are determined through direct negotiations between buyers and sellers. This flexible trading method attracts many small and medium-sized enterprises, startups, and companies that meet listing requirements but prefer to maintain privacy. With the development of the internet, the OTC market has rapidly expanded, becoming an important channel for global investors to access diverse assets.

## What Products Are Covered in OTC Markets?

OTC markets offer a much wider range of products than on-exchange trading. Besides traditional stocks and bonds, they include:

**Stocks:** OTC stocks mainly consist of small companies and startups that do not meet listing requirements or have not applied for listing, which cannot be found on major exchanges.

**Bonds:** Due to the large issuance volume, variety, and infrequent trading of bonds, OTC markets are more suitable for bond transactions than on-exchange markets.

**Derivatives:** Contracts such as options, futures, and CFDs are also traded OTC.

**Foreign Exchange and Cryptocurrencies:** Currency trading on major platforms is OTC; cryptocurrencies can be purchased in large quantities off-exchange, which is difficult to achieve in specialized markets.

## How Does Taiwan’s OTC Market Operate?

Taiwan’s stock market is divided into two layers: the "Stock Exchange" and the "OTC Securities Exchange" (GTSM). The OTC index (GTSM index) reflects the status of Taiwan’s OTC stock market, and many investors observe this index to gauge the trend of small and medium-sized stocks.

The government established the GTSM to balance the listing thresholds. Strict listing standards can hinder company development, especially for startups with potential but limited funds. Therefore, GTSM relaxes conditions: companies only need to be recommended by more than two licensed brokers to list, and if they show performance improvements (profitability or structural improvements) within six months, they can apply to transfer to the main board.

However, the lower entry barrier has also attracted some unscrupulous companies and bad brokers who recommend high-risk targets for speculative profits. Therefore, investors need to carefully select quality targets and reputable brokers.

### OTC Stock Trading Process and Rules

Investors buy and sell OTC stocks in the same way as listed stocks:

1. **Order Placement:** Submit buy/sell orders through a broker.
2. **Matching:** The broker uploads orders to the GTSM’s automated matching system (ATS), which pairs trades based on "price priority, time priority."
3. **Settlement:** Using T+2 settlement, transactions are settled two business days after execution.

**Trading hours and matching rules:**
- Pre-market: 08:30–09:00
- Regular trading: 09:00–13:30
- After-hours pricing: 13:40–14:30
- Call auction interval: every 5 seconds
- Price fluctuation limit: ±10% (same as listed stocks)

OTC trading rules are identical to those of the main market, including price limits, call auctions, matching, and daily trading hours. Companies must comply with disclosure regulations, including quarterly and annual reports and major news, ensuring higher transparency than OTC over-the-counter trading.

## On-Exchange Trading vs. OTC Trading: Seven Key Differences

| Aspect | On-Exchange Trading (Main Market) | OTC Trading |
|---------|----------------------------------|--------------|
| Product Standardization | Standardized | Non-standardized |
| Trading Mode | Call auction | Negotiated trading |
| Trading Venue | Centralized exchange, electronic systems | No centralized venue, decentralized |
| Main Products | Standard securities, bonds, futures, funds | Non-standardized derivatives, forex, unlisted stocks |
| Regulation | Strict government and regulatory oversight | Relatively relaxed regulation |
| Transparency | Public prices and volumes | Not necessarily public |
| Trading Volume | Large | Small |

**① Difference in Product Specifications**

On-exchange trading involves standardized products; OTC trading involves non-standardized products. For example, gold trading on an exchange is like going to a bank with uniform standards; OTC gold trading is like pawnshops, where conditions vary. Pawnshops can trade a wider variety of goods and are more irreplaceable compared to banks.

**② Difference in Trading Modes**

On-exchange trading’s call auction is transparent and relatively fair but offers limited profit margins. OTC trading lacks transparency, with buyers and sellers freely negotiating prices, making information more critical—those with better information can find better trading opportunities.

**③ Product Diversity**

On-exchange trading mainly involves standardized securities and futures, resulting in fewer product types. OTC trading covers a broad range, including forex CFDs, cryptocurrencies, and unlisted stocks, with very diverse product offerings.

**④ Trading Platforms and Regulation**

On-exchange trading is approved and regulated by the government. OTC markets are operated by brokers, often via online trading, with only some under formal regulation. OTC trading does not necessarily occur on government-approved exchanges, posing risks of fraud through fake trading platforms.

**⑤ Transparency**

On-exchange markets publicly disclose prices and trading volumes. OTC markets do not always disclose trading details, leading to information gaps. Experienced traders can profit from this asymmetry, while inexperienced investors may suffer excess losses.

**⑥ Liquidity and Trading Volume**

On-exchange markets have high liquidity and large trading volumes. OTC markets tend to have lower liquidity and smaller volumes. Due to proper regulation, on-exchange trading is more reassuring for investors, attracting international capital.

**⑦ Trading Methods and Leverage**

On-exchange trading has limited methods, strict risk controls, and restrictions on leverage and short selling. OTC trading offers more flexibility, allowing investors to utilize higher leverage to amplify gains.

## Advantages of OTC Trading

✔️ **Broader Investment Options:** Enables access to derivatives, binary options, CFDs, forex, and other diverse products, expanding market choices.

✔️ **More Flexible Trading:** Product specifications and trading methods are more adaptable, allowing personalized strategies based on investment goals.

✔️ **Greater Leverage Flexibility:** Traditional markets have low leverage and many restrictions; OTC offers various leverage options, enabling higher leverage to boost returns.

✔️ **Enhanced Risk Management Tools:** Modern OTC markets have gradually improved, providing multiple safety mechanisms. Reputable brokers are authorized and regulated by financial institutions, making trading safer once investors are well-informed.

## Risks and Challenges of OTC Trading

❌ **Lack of Regulation:** OTC markets lack unified rules; laws and oversight are relatively lenient, leading to many fraudulent brokers operating. Many companies and securities that do not meet on-exchange standards can only trade OTC.

❌ **Limited Liquidity:** OTC securities have lower liquidity than centralized exchanges, which may hinder achieving desired prices and affect entry and exit efficiency.

❌ **Market Volatility Risks:** Similar to stock markets, OTC trading is affected by market fluctuations. Due to lack of transparent information, most OTC investors face higher information asymmetry risks.

❌ **Counterparty Credit Risk:** Buyers and sellers negotiate directly, and sellers may offer different prices to different buyers. Some products are highly volatile with low liquidity; there is also a risk of fraud through false information.

## Is OTC Trading Safe?

OTC trading is not regulated by centralized exchanges, but that does not mean it is completely unsafe. Compared to on-exchange trading, OTC involves certain risks, but these can be mitigated with proper precautions.

**The first priority is to ensure broker safety.** Choose brokers regulated by multiple authorities, with strong risk controls, and offering investor protection measures such as risk assessments, KYC procedures, and complaint mechanisms.

**Secondly, select mature trading products,** such as forex, and fully understand details like spreads, liquidity, and withdrawal procedures for comprehensive evaluation.

Regulated OTC platforms usually have investor protection measures in place, helping to reduce trading risks. Investors must choose government-approved and regulated trading platforms to ensure safety.

## Summary: What Is OTC and Investment Recommendations

What is OTC? In short, it is an investment arena outside of traditional exchanges, offering a wider range of products, more flexible trading methods, and higher leverage. It is especially suitable for investors seeking non-standardized products.

However, OTC trading also carries risks. Before participating, investors should:

1. Choose regulated trading platforms and brokers
2. Fully understand the characteristics and risks of traded products
3. Establish comprehensive risk management strategies
4. Acquire sufficient market knowledge and information
5. Avoid being misled by promises of high leverage and high returns

Overall, OTC is mainly focused on small and medium-sized, growth-oriented companies, with higher volatility but more attractive themes and growth potential. Due to its unique nature, OTC trading requires caution, but for knowledgeable and risk-aware investors, it indeed offers unique investment opportunities.