Understanding the OTC Market: Balancing Flexibility and Risks in Over-the-Counter Trading

Investors often face a dilemma: they identify promising companies but can’t find listing information on mainstream exchanges. This is where the OTC market comes in—the over-the-counter platform offers a vast, diverse trading environment outside formal exchanges. OTC trades are not location-restricted; prices are negotiated directly between parties, offering greater flexibility than centralized exchanges. However, this flexibility comes with risks such as looser regulation and less transparent information. Understanding how the OTC market operates, its product features, and safety considerations is crucial for anyone interested in engaging in OTC trading.

Core Definition of the OTC Market: Beyond Traditional Exchanges

OTC stands for “Over The Counter,” also known as “over-the-counter trading,” sometimes called “pink sheets” or “desk trading.” Simply put, the OTC market is a platform where investors buy and sell various assets directly through dispersed channels—banks, brokerages, phone systems, or electronic platforms—without trading on centralized exchanges like securities markets.

Unlike centralized exchanges, OTC prices are not set through uniform bidding; instead, they are negotiated between counterparties based on market conditions. This means the same asset can have different prices depending on the counterparty, which could be a bank, securities firm, corporation, or individual investor.

Companies entering the OTC market generally fall into two categories: one, small to medium-sized or startup firms that do not qualify for exchange listing; and two, companies that meet listing requirements but choose OTC to avoid excessive disclosure and competitive pressure. With the growth of the internet, OTC markets have expanded rapidly, becoming one of the largest trading sectors globally, offering investors broader choices and greater convenience.

OTC Market Products: From Traditional Stocks to Modern Derivatives

The range of products traded OTC far exceeds that of traditional exchanges, covering multiple asset classes:

Stocks — Besides listed stocks on major exchanges, OTC markets offer many unlisted or unreported small-cap stocks, especially early-stage company shares. This provides opportunities to participate in early growth, albeit with higher risks.

Bonds — OTC markets handle large volumes of bonds, including a wide variety of types that are less frequently traded on exchanges. Issuers range from government agencies to private companies, offering diverse credit profiles.

Derivatives — Options, futures, CFDs, and other complex financial instruments are primarily traded OTC. These products are often non-standardized and highly customizable.

Foreign Exchange — Nearly all global currency trading occurs OTC, connected through various platforms, with volumes surpassing exchange-traded forex.

Cryptocurrencies — Major cryptocurrencies are traded OTC, allowing investors to purchase large amounts of digital assets in a single transaction—something difficult to achieve on spot markets.

How the OTC Market Works: From Matching to Settlement

Understanding the OTC process helps investors assess risks and opportunities. Using Taiwan’s OTC market as an example, the process is relatively standardized:

Step 1: Investor Places Orders
Investors submit buy or sell orders for OTC stocks through brokerages, identical to procedures for listed stocks, with no special steps needed.

Step 2: Orders Enter the Matching System
Brokerages upload orders to the OTC’s automated trading system (ATS). The ATS matches orders based on “price priority” and “time priority,” executing trades with counterparties in accordance with the same technical rules as the main market.

Trading Hours and Rules

Core Rules Remain Consistent:

• Price limits (±10%) similar to the main market
• Use of call auction system (adopted by Taiwan’s listed and OTC markets)
• Matching trades executed within designated hours

Step 3: Settlement Completion
OTC stocks follow a T+2 settlement cycle (trade date plus two business days), identical to listed stocks, ensuring stability.

To list on OTC, companies must comply with disclosure rules, regularly releasing quarterly and annual reports and material information. This transparency surpasses that of the emerging OTC markets, providing investors with relatively sufficient information. Overall, OTC markets mainly involve small to medium-sized and growth-oriented companies, with higher volatility but more thematic and growth potential. Since liquidity is better than emerging markets and regulations align with main markets, the barrier for retail investors to participate in OTC stocks is relatively low.

Taiwan’s OTC Market Features: The OTC Center and Market Structure

Taiwan’s stock market comprises the “Stock Exchange” and the “OTC Securities Center.” The government established the OTC Center to address a practical dilemma: overly strict listing standards hinder startup growth, but a completely unregulated market could lead to chaos.

The OTC index (also called the “Gretai Index”) reflects the overall condition of Taiwan’s OTC stock market. Many investors monitor this index to gauge the trend of small and medium-sized stocks.

To attract promising but immature companies, the government relaxed OTC entry criteria—companies with at least two broker recommendations can apply. If a company shows significant progress within six months (such as improved profitability or financial health), it can apply to transfer to the main or OTC markets.

However, lenient rules also bring issues. Besides genuine startups lacking funding, the OTC market attracts many questionable companies. More dangerously, some fraudsters impersonate unlicensed brokers, promoting high-risk stocks with false information to “harvest” investors—similar to the tactics depicted in the movie “The Wolf of Wall Street,” involving high-risk “pink sheets.” Therefore, investors aiming to profit from OTC should carefully select reputable, regulated brokers.

Comparing OTC and On-Exchange Trading

The original purpose of centralized exchanges was to set standards and rules. Compared to the strict regulations of on-exchange trading, OTC markets are closer to the fundamental economic principle of supply and demand. There are significant differences across multiple dimensions:

Deep Dive into Key Differences:

Product Standards — Standardized vs. Non-standardized
Exchange-traded products are like exchanging gold at a bank—uniform standards apply. OTC products resemble pawning—each item varies. Pawning involves complex procedures but offers a broader range of tradable items.

Trading Mode — Call Auction vs. Negotiation
Exchange trading is transparent and fair but offers limited profit margins. OTC trading involves bilateral negotiations, allowing for private pricing. Since OTC trades are not public, even higher bids may not guarantee purchase, making “information more valuable than capital” in OTC.

Main Products
Exchanges mainly handle securities and futures, which require standardization. OTC markets feature a wide array of products like forex CFDs, cryptocurrencies, and unlisted stocks, with highly diverse offerings.

Platforms and Regulation
Exchanges are government-approved and strictly regulated; OTC trading is conducted via various brokerages with varying oversight. OTC trades are not always on government-approved platforms, increasing the risk of scams. Investors should choose regulated, reputable platforms for safety.

Transparency
Exchanges disclose all transaction prices and volumes; OTC markets often do not. Due to weaker regulation, information gaps are common, enabling savvy traders to profit from asymmetries while others may suffer losses.

Volume and Liquidity
Regulated exchanges attract international capital, resulting in high trading volume and liquidity. OTC markets tend to have lower volume and liquidity, making quick exit at desired prices more difficult.

Flexibility of Trading
Strict regulation on exchanges limits leverage and short-selling. OTC markets are more permissive, allowing investors to leverage and short more freely.

The Dual Nature of OTC Markets: Opportunities and Risks

✔️ Core Advantages of OTC Markets

Broader Investment Options
OTC markets provide access to a wider array of instruments—derivatives, binary options, CFDs, forex—beyond traditional stocks.

Flexible Trading Methods
OTC products and trading styles are highly customizable, enabling investors to tailor strategies to their goals without the constraints of standardized exchange rules.

Greater Leverage
Mainstream exchanges often limit leverage; OTC markets offer multiple leverage options, amplifying potential gains.

Gradual Security Improvements
Modern OTC markets are enhancing safety measures, approaching the standards of centralized markets. Many reputable brokers, licensed and regulated by well-known financial authorities, offer professional services. With proper knowledge, investors can trade OTC more confidently.

❌ Core Risks of OTC Markets

Lack of Regulation and Fraud
OTC markets lack unified rules and transparency, with relatively loose oversight. Many fraudulent brokers operate within OTC, unlike listed companies that must comply with strict regulations. Companies or securities not meeting these standards are only tradable OTC, increasing risk.

Liquidity Risk
OTC securities generally have lower liquidity than centralized exchanges, making it harder to exit positions at desired prices, especially during volatility.

Market and Information Asymmetry Risks
OTC trading is affected by market fluctuations, but most OTC investors lack the transparency of exchange trading, complicating decision-making. Some assets are highly volatile with low liquidity, increasing risks. Deceptive information may be used to lure investors.

Counterparty Risk
OTC trades are bilateral, exposing investors to the credit risk of their counterparties. Default or insolvency can lead to significant losses.

Essential Precautions Before Entering OTC Markets

Is the absence of exchange regulation a guarantee of danger? Not entirely, but risks do exist.

Compared to centralized exchanges, OTC markets inherently carry more risk. Without unified rules, prices are negotiated, and the same stock might be sold at different prices to different buyers. To mitigate these risks, investors should establish clear safeguards:

First Line of Defense: Choose Reputable Brokers
Select brokers regulated by authoritative agencies (e.g., ASIC, CIMA, FSC) with strong risk controls. Verify their licensing before trading.

Second Line: Focus on Mature Products
Begin with highly liquid, well-established assets like forex. Fully understand their spreads, liquidity, withdrawal rules, and other details before investing.

Third Line: Investor Protection Measures
Some legitimate OTC platforms offer protections such as risk assessments, KYC procedures, complaint mechanisms, and negative balance protection, reducing certain risks.

Fourth Line: Self-Education and Risk Management
Learn technical analysis, proper capital management, and psychological discipline. Use limit orders and stop-loss tools to control losses. Never over-leverage or invest all funds at once; keep emergency reserves.

For those interested in OTC trading, recognizing its flexibility and risks is the first step toward success. OTC markets are not inherently scams nor guaranteed profit zones—they are different in rules, risks, and potential rewards. By choosing regulated brokers, acquiring proper knowledge, and implementing sound risk controls, investors can find their own opportunities within OTC markets.