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If you want to get involved in the financial markets, you need to know about the over-the-counter (OTC) market. It represents an integral part of how businesses and individuals trade financial assets in the stock market.
Companies of all sizes make use of the OTC market because of how convenient it is to use. If you’re thinking of investing in stocks, you should know more about these OTC stocks.
Are you curious about investing in Forex and the OTC market? Check out this guide on what the OTC market is along with the benefits and risks.
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The OTC Market is the decentralized network of broker-dealers for stocks and securities not listed on a centralized exchange, such as the NASDAQ or NYSE. Over-the-counter is a reference to how securities in this market are traded, which is directly between buyer and seller. There are over 10,000 securities on the OTC market.
Bonds, currencies issued by central banks, derivatives, and commodities can all be traded in the OTC market. These securities are not available on the major exchanges, which makes the OTC market very attractive to new and ambitious investors. Forex currency trading is by far the most popular OTC market.
The OTC market is comprised of a few different trading networks run by the OTC Markets Group. Let’s take a look at these networks.
The OTCQX network is often called the “Best Market” because it trades the highest quality stocks of the three OTC networks. Companies on the OTCQX have the highest liquidity and market cap of the three networks. These companies are also financially transparent and jump through many hoops to prove that transparency.
Companies listed on the OTCQX must meet certain requirements. In order to be listed a company cannot be going through bankruptcy, be a shell company, or trade at less than five dollars a share. Stocks that are worth less than five dollars a share are considered “penny” stocks.
Trading on the OTCQB network comes with the lowest risk of the three exchanges. Many of the companies that are listed on this network hope to one day list on the NASDAQ or NYSE. Because of this they are incentivized to be as open and financially responsible as possible.
The OTQB network is also called the “Venture Market” and trades companies that are small and growing. The companies in this network undergo far less scrutiny compared to those listed on the OTCQX.
Similarly to the OTCQX network, companies on the OTCQB cannot be in bankruptcy. They must also be financially audited once a year according to the standards of the U.S GAAP. OTCQB companies must list it at a price no less than $0.01.
Trading on the OTCQB network comes with a greater degree of risk than trading on the OTCQX. Companies on this network are held to a lower standard than the companies listed on the OTCQX, which means they have less incentive to be financially responsible.
The OTC Pink Market or “Pink Sheets” is the most open and unregulated trading network. Pink Sheet companies have almost no requirements to be listed in the Pink Market. They are not required to submit financial audits or disclose financial information to the Securities and Exchange Commission (SEC).
Pink Market companies are required only to be registered with the Financial Industry Regulatory Authority (FIRA). They can provide as much information as they choose to. Many Pink Sheet companies are shell companies or pump and dump schemes.
Lack of regulatory oversight makes the Pink Market the riskiest of all the OTC markets. Pink Sheet stocks are usually penny stocks and many of them are worth less than $0.01. Trading in this low-cost, high-risk market can also yield high returns.
The Gray Market is an unofficial trading market for stocks that have been suspended from trading on the market, or for new securities that are bought and sold before they are officially traded. The Gray Market is generally avoided by investors like mutual funds and pension funds, but is attractive to certain retail investors. Like the Pink Sheet market, companies on the Gray Market are not required to disclose financial information to the SEC or submit to financial audits.
Forex currency trading, or foreign exchange currency trading, is the most popular OTC market. Foreign currencies traded over-the-counter are not attached to traditional exchanges. This means that they trade in real-time for 24 hours a day, 5 days a week.
The forex market has extreme liquidity, high volatility, and low trading fees. FX trading is one of the largest markets in the world, exchanging an average of $5 trillion dollars a day.
There are a number of currencies that can be traded in the forex markets. Currencies are traded in pairs and some of the most popular pairs are euro/US dollar (EUR/USD), US dollar/Japanese yen (USD/JPY), US dollar/Chinese renminbi (USD/CNY), and British pound/US dollar (GBP/USD).
Every currency pair has a base currency and a quote currency. The base currency is the first currency and the quote currency is the second currency. For example, in the EUR/USD pair, the euro is the base currency and the US dollar is the quote currency. If the pair’s exchange rate is at 1.0443, then one euro is worth 1.0443 US dollars.
Trading in the OTC markets can be very beneficial.
The biggest benefit for traders in the OTC markets is the possibility for large returns on investment. OTC trading has a much lower cost barrier than trading on the major exchanges, so because of this the same investment in an OTC stock will go further than it would a stock on a major exchange.
The OTC markets give traders access to companies that are growing but aren’t yet large enough to be listed on the NASDAQ or NYSE. Investing in a company before it gets listed on a major exchange can yield an incredible ROI. OTC traders also have access to foreign companies that trade on exchanges outside of the U.S.
Another benefit of the OTC markets is privacy. Due to the decentralized nature of OTC networks, traders are afforded a level of discretion and privacy that major exchanges don’t have.
Trading in the OTC market doesn’t come without risks. Like with any type of investment, securities in the over-the-counter market are speculative and come with an inherent level of risk.
As previously mentioned, the companies in the OTC markets are not always transparent or trustworthy. Pink Sheet stocks very often end up as pump and dumps. Investing in shady companies or shell companies are good ways to lose money very quickly.
OTC stocks are less liquid than the stocks on a major exchange. OTC companies generally have a much smaller market cap than those listed on NASDAQ or NYSE. This results in wider bidding ranges and asking spreads.
The low liquidity of OTC stocks also contributes to their extreme volatility. The low-cost nature of penny stocks attracts investors to buy large amounts of shares. The buying and selling of those shares leads to extreme movements in price.
While risk can never be completely eliminated, learning how to properly manage risk can minimize any potential losses you may suffer while trading.
There are a number of differences between the OTC markets and the major trading exchanges.
For starters, exchanges have a centralized physical location where all trades take place. Traders and brokers come together and communicate verbally on buys and sells. Comparatively, the OTC markets are decentralized and trading is done electronically through phone, email, and the internet.
OTC trades happen directly between two parties without a broker or centralized exchange. Trades on an exchange must go through a third party and have next to no privacy. All trades on an exchange are public.
The major exchanges must follow many rules and regulations. These restrictions force companies to be transparent and honest about their operations which builds trust with investors. Stocks on the major exchanges are highly liquid as a result and investors can expect to have fair trades.
Trading in the OTC markets can occur at any time due to its decentralized nature. Trading on major exchanges must occur within a time frame, usually somewhere between 8am and 4pm, and only happens five days (Monday through Friday) a week.
Trading in the Forex and OTC markets can be extremely rewarding, but can also come with a high level of risk. Ultimately, it is up to you to decide your own risk/reward ratio. Doing proper research by avoiding scams and bad companies while implementing a safe, reliable trading strategy will lead to long-term success in the OTC market.
Are you interested in learning more about forex trading and how the OTC markets work? Try a risk free demo or live account to put your trading knowledge in action.
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