An Over Counter market is a network of companies that serve as a market maker for certain inexpensive and low-traded stocks. Stocks that trade on an exchange are listed stocks, whereas stocks sold over the counter are unlisted.
The OTC market is a decentralized market offering trading in almost all asset classes, like stocks, bonds, currency, and commodities. In addition, it may provide trading in financial derivatives.
Although there are differences between OTC and stock exchange, investors shouldn’t experience significant variations when trading. A stock exchange is a regulated, standardized market that could be considered safer as customers deal with the stock exchange through a member broker. Whereas in the OTC market, there is no centralized exchange.
Types of OTC Markets
An OTC market could be split into two types:
- Customer Market,
- Dealer Market.
Features of OTC Market
- The OTC market has seen improvements in recent years. It results in higher liquidity and better information for traders.
- Electronic quotation and trading have enhanced the OTC market; however, the OTC market is still characterized by several risks that are usually not there in stock exchanges.
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. It can give some investors added assurance and confidence in their transactions. How securities are traded plays a critical role in price determination and stability.
OTC Exchange of India
OTC Exchange of India (OTCEI) was founded in 1990 under the Companies Act 1956 and got recognized by the Securities Contracts Regulation Act 1956 as a stock exchange. It has a pattern along the lines of the NASDAQ market and has introduced several innovations to the Indian capital market like:
- Screen-based nationwide trading.
- Sponsorship of companies.
- Market making.
- Scrip less trading.
Risks of OTC Trading
Fraudulent activities aside, there are other risks associated with OTC trading.
Lack of Price Transparency
In an OTC market, a seller may charge a buyer one for security and quote a different price to another buyer.
Low Liquidity
Many OTC stocks are thinly traded, meaning there isn’t much demand. That can make them hard to sell when you want to.
Price Volatility
Since OTC securities experience lower trading volume, it may lead to sharp price swings.
Lack of Regulation
Depending on the market or OTC network you choose to trade through, OTC trading may have less regulation than significant exchanges.
Conclusion: Trade in OTC Market with Caution
OTC trading is not for everyone. OTC stocks could be highly illiquid; are frequent targets of alleged market manipulation. You should avoid an OTC market if you’re a conservative or relatively novice investor.
Investors transacting over the counter should carefully understand the risks associated with trading there. For example, in most countries, OTC exchanges might be illiquid or dysfunctional.
Be aware of trading at an OTC exchange!
