OTC stands for over-the-counter. In trading terms, over-the-counter means trading through decentralized dealer networks. A decentralized market is simply a market structure consisting of various technical devices. This structure allows investors to create a marketplace without a central location. The opposite of OTC trading is exchange trading, which takes place via a centralized exchange.

An example of OTC trading is a security, currency, or other financial product being bought through a dealer, either by telephone or electronically. Business is typically conducted by telephone, email and dedicated computer networks. The OTC market is arranged through brokers and dealers who negotiate directly. An advantage of the OTC market is that non-standard quantities of stock can be traded.

The OTC market often includes smaller securities. It consists of stocks that do not need to meet market capitalization requirements. OTC markets could also involve companies that cannot keep their stock above a certain price per share, or who are in bankruptcy filings. These types of companies are not able to trade on an exchange, but can trade on the OTC markets.

OTC markets

The over-the-counter market is a network of companies which serve as a market maker for certain inexpensive and low-traded stocks such as penny stocks. Stocks which trade on an exchange are called listed stocks, whereas stocks which are traded over the counter are referred to as unlisted stocks.

Although there are differences between OTC and major exchanges, investors shouldn’t experience any major variations when trading. A financial exchange is a regulated, standardized market and is therefore considered safer. It may also be seen as enabling faster transactions.

What are the risks of OTC trading?

The OTC markets have experienced improvements in recent years. This results in higher liquidity and better information. Electronic quotation and trading have enhanced the OTC market. However, OTC markets are still characterized by a number of risks that may be less prevalent in formal exchanges.

Regulations

Investors may, however, experience additional risk when trading OTC. While brokers and dealers operating in the US OTC markets are regulated by the Financial Industry Regulatory Authority (FINRA), exchanges are subject to more stringent regulation than OTC markets.

Transparency 

OTC prices are not disclosed publicly until after the trade is complete. Therefore, a trade can be executed between two parties via an OTC market without others being aware of the price point of the transaction. This lack of transparency could cause investors to encounter adverse conditions. Comparatively, trading on an exchange is carried out in a publicly transparent manner. This can give some investors added assurance and confidence in their transactions. How securities are traded plays a critical role in price determination and stability.

Volatility

Another factor with OTC stocks is that they can be quite volatile and unpredictable. They can also be subject to market manipulation, so risk management techniques are recommended when trading. A stop-loss order will automatically close a position once it moves a certain number of points against the trader. A limit will close a position once it moves a certain number of points in favor of the trader. For both types of orders, traders can set triggers at predetermined price levels so they can define their profit and loss amounts in advance.

Requirements

So how does a company make the jump to a major exchange? It must meet the new exchange’s financial and regulatory requirements. These include price per share, corporate profits, revenue, total value, trading volume and reporting requirements. Reports are filed and can be viewed by the public. Shareholders and the markets must be kept informed on a regular basis in a transparent manner.

The NYSE requires all its listed companies to have 1.1 million publicly held shares. These must be held by a minimum of 2,200 shareholders and the minimum share price must be $4.00. It also asks for an average monthly trading volume of 100,000 shares.