What is OTC? A comprehensive guide to the core mechanisms of over-the-counter trading

Many investors discover that some companies are not listed on mainstream exchanges but can still be bought and sold. This is the operation of the OTC (Over The Counter) market. As an important part of the global financial system, OTC markets often have trading volumes exceeding those of centralized exchanges, yet their operating logic and risk characteristics are less well known. What exactly is OTC? How does it work? What should participants pay attention to? This article will analyze these questions one by one.

The True Face of OTC Trading: From Definition to Operation Principles

OTC stands for Over The Counter, also known as “off-exchange trading,” “over-the-counter trading,” or “over-the-counter market.” Unlike centralized exchanges, OTC trading does not occur in a unified marketplace but is conducted directly between trading participants—such as banks, brokerages, companies, or individual investors—via phone, electronic systems, or dispersed broker counters.

This decentralized trading method brings fundamental differences: OTC prices are not determined by a central bidding process but are negotiated directly between buyers and sellers. The same company’s stock may be sold at different prices to different buyers, exemplifying the information asymmetry inherent in OTC markets.

Why do companies choose OTC trading instead of formal exchanges? Usually because these companies—often small or startup firms—do not meet the listing requirements of exchanges, or they meet the criteria but prefer OTC to avoid extensive disclosure. In recent years, with internet development and increasing investor demand for trading convenience, OTC markets have rapidly expanded and become a significant global trading channel.

Types of Products Traded in OTC Markets

OTC trading covers a much broader range of products than many realize:

Stocks: Besides listed stocks on centralized markets, OTC markets also offer stocks of unlisted or unlisted small and medium-sized enterprises, which often have higher growth potential but also higher risks.

Bonds: Due to large issuance volumes, diverse types, and infrequent trading, OTC markets are actually more flexible than centralized exchanges for bond trading.

Derivatives: Contracts such as options, futures, and CFDs are also traded OTC, providing more customized hedging tools.

Foreign Exchange: Transactions on various global currency platforms are essentially OTC trades.

Cryptocurrencies: Popular digital assets can be traded OTC, enabling large one-time transactions that are often difficult to execute on dedicated crypto exchanges.

Seven Key Differences Between OTC Markets and Centralized Exchanges

Understanding OTC trading requires comparing it with centralized exchanges:

These differences reflect the fundamental philosophies of the two markets. Centralized exchanges pursue standardization and transparency, with uniform product specifications, strict rules, and information symmetry. OTC trading aligns more with the basic supply and demand principles of economics, emphasizing flexibility and customization.

The Cost of Transparency: For example, gold trading on a centralized exchange resembles bank-standard quotes—uniform across providers; OTC gold trading is like pawnshop negotiations—each deal varies. While pawnshops offer more product variety, they require more bargaining skill.

Information and Capital Battles: In centralized markets, the size of capital often determines success; in OTC markets, the party with better information gains greater bargaining power. This is why investors unfamiliar with OTC rules may face excessive losses.

The Specific Operating Mechanism of Taiwan’s OTC Market

Taking Taiwan as an example, its stock market is divided into the “Taiwan Stock Exchange” and the “OTC Securities Exchange,” the latter being Taiwan’s OTC market. The OTC index (also called the OTC Composite Index) is an important indicator for investors observing small and medium-sized stocks.

This division aims to create a development ladder for companies: strict listing requirements filter for larger firms, but this also hampers financing for many startups. To address this, the government established the OTC center, significantly lowering listing criteria—companies only need recommendations from two or more qualified brokers to list.

Taiwan OTC Trading Hours and Rules:

• Pre-market call auction: 08:30-09:00
• Regular trading hours: 09:00-13:30
• Post-market pricing: 13:40-14:30
• Call auction frequency: every 5 seconds
• Price fluctuation limit: ±10% (same as listed market)
• Settlement system: T+2 (identical to listed stocks)

OTC stocks follow nearly the same trading rules as listed stocks, including price limits, call auction matching, and automated trading systems, greatly lowering the participation barrier for ordinary investors.

The Double-Edged Sword of Listing: Due to relatively lenient application conditions, many promising startups seek financing here. However, it also attracts companies of varying quality, and some unscrupulous brokers may recommend high-risk targets for “harvesting” investors, similar to scenes depicted in the movie “The Wolf of Wall Street.”

Risks of Participating in OTC Trading

On the surface, OTC markets’ flexibility and diverse products are attractive, but the hidden risks should not be overlooked.

Regulatory Vacuum Risks: OTC markets lack unified regulations, and legal oversight is relatively loose, allowing fraudsters to exploit loopholes. Entities that do not meet formal exchange requirements often become hotbeds of illegal trading.

Liquidity Risks: OTC securities have significantly lower liquidity than centralized markets. When investors want to exit, they may find no buyers at desired prices or even face the inability to sell at all.

Information Asymmetry Risks: Investors often cannot access the same quality of public information as in centralized markets. Malicious actors may exploit this gap by spreading false information to deceive investors.

Market Volatility Risks: Due to fewer participants and lower liquidity, OTC securities are more susceptible to sudden shocks from news or market sentiment, leading to more volatile prices.

How to Safely Enter the OTC Market

OTC markets are not inherently unsafe; the key lies in how investors manage risks. Here are core strategies to reduce exposure:

First: Choose Regulated Trading Platforms. Any platform should be under strict supervision by government-authorized regulators. For example, platforms holding licenses from ASIC (Australia), CIMA (Cayman Islands), and FSC (Mauritius) are relatively more compliant.

Second: Prioritize Mature Trading Products. Beginners should start with more established, liquid assets like forex or mainstream cryptocurrencies to understand spreads, liquidity, and deposit/withdrawal mechanisms.

Third: Assess Broker’s Risk Control Measures. Legitimate platforms offer risk assessments, KYC procedures, complaint mechanisms, and risk management tools like stop-loss orders and negative balance protection.

Fourth: Develop Information Literacy. Due to information asymmetry, investors need to cultivate the ability to filter information, monitor market developments, understand basic financial concepts, and avoid being misled.

The future of OTC is trending toward increased regulation. As global oversight intensifies, many OTC platforms are improving their security standards to gain investor trust. Under proper understanding, choosing compliant platforms, and establishing risk awareness, investors can find opportunities in this market.

OTC, at its core, is a highly flexible yet vigilant market. It provides financing channels for companies unable to access centralized exchanges and opens investment opportunities for those seeking diversification, but it also demands stronger information discernment and risk management from participants.