OTC (over-the-counter) securities are securities that trade via a broker-dealer network instead of on major exchanges like the NYSE. OTC securities can include stocks, bonds, and derivatives (contracts that derive value from an underlying asset).
OTC securities are assets that trade between parties without listing on an exchange. The OTC marketplace allows small companies and firms that can’t or don’t meet strict exchange requirements to issue securities.
With often-cheap buy-in prices and the potential to see rapid gains, OTC securities seem promising. However, OTC markets are famous for low liquidity, high volatility, and less financial transparency and regulation. As such, they pose greater risk of fraud and market manipulation.
Over 10,000 securities trade OTC, including stocks, bonds, commodities, and derivatives.
For some securities, like corporate bonds, the OTC market is the default “exchange,” as issuers can bypass hefty listing fees. (Listing on the NYSE alone can cost $295,000.) It’s also a viable marketplace for companies that can’t or don’t meet listing requirements like trade volumes, number of shareholders or financial reporting standards.
Some firms remain unlisted by choice or use OTC securities to quickly access capital. Others, like American Depository Receipts (ADRs), represent shares in foreign companies that don’t meet U.S. standards.
OTC securities generally trade on electronic interdealer quotation systems called Alternative Trading Systems. Market makers and broker-dealers rely on ATSs to publish OTC bid and ask prices.
Each ATS sets its own eligibility standards: while some require regular financial reports to the SEC, others hold laxer standards. OTC Markets, the largest OTC marketplace, groups investments based on the quality and quantity of information available:
Unlike the NYSE, OTC markets don’t have a physical location. But for most investors, buying OTC securities is no different than trading listed stocks.
Generally, you can buy OTC securities through most major brokers online or over the phone. However, your broker may set higher fees or trading restrictions. For instance, many limit OTC trading hours or require limit orders to minimize the risk of closing at undesirable prices.
Brokers set these limits to minimize the risks of OTC market volatility. And the higher fees can encourage OTC market makers to carry a robust inventory to facilitate trading.
OTC securities are popular with some investors due to their potential for quick gains, as well as their wide range of investments.
However, OTC markets may have a higher risk of fraud, as well as lower liquidity, and higher volatility than major exchanges. And while some companies do file reports with the SEC, many don’t, leaving you with less information to make informed trading decisions.
As such, we generally advise that investors leave OTC trading to the pros. (Or at least, thoroughly research any OTC securities before purchase.)
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