What exactly is OTC (Over-the-Counter) trading? Risks and opportunities investors need to understand

Definition and Operating Mechanism of OTC Trading

OTC (Over The Counter) trading, simply put, is when investors bypass centralized exchanges and directly conduct one-on-one transactions with dealers through established trading networks. When investors are interested in a company but cannot find its presence on mainstream exchanges, the OTC market becomes an inevitable choice.

Unlike the standardized processes of formal exchanges, OTC trading adopts a decentralized approach, primarily conducted through brokers, bank counters, phone, or electronic platforms. This market lacks unified trading rules and instead relies on buyers and sellers negotiating prices based on market supply and demand. Companies that typically trade OTC are often small to medium-sized or startup projects that do not meet listing requirements for formal exchanges. However, this does not mean these companies lack investment value.

In recent decades, with the rapid expansion of international financial markets and the development of internet technology, the OTC market has grown swiftly and has become an important trading channel for global investors. The demand for trading convenience and asset accessibility continues to rise, driving the prosperity of the OTC market.

What is OTC: Types of Tradable Assets

The asset classes covered by OTC trading are far more diverse than those on exchanges, mainly including:

Stock Assets

Stocks remain the largest investment sector in OTC markets. Compared to listed stocks, OTC stocks cover a broader range, including stocks of micro and small companies and startups that do not meet listing standards. For companies with growth potential but smaller scale, OTC trading provides an important financing and trading channel.

Bonds and Fixed Income Products

Bonds are issued in large volumes and various types but have relatively low trading frequency. The OTC market is more suitable for bond trading than exchanges. Corporate bonds, local government bonds, and other bond products are all liquid in OTC markets.

Financial Derivatives

Options, futures, spread contracts, and other derivative instruments are widely available in OTC markets, offering investors diversified risk management and profit amplification tools.

Foreign Exchange Trading

Currency trading on various global platforms is essentially OTC trading, with forex being the largest asset class in OTC markets.

Cryptocurrencies

Popular cryptocurrencies can be traded in OTC markets. The advantage of OTC mode is supporting large one-time purchases of crypto assets, which are often difficult to achieve on professional crypto exchanges.

American Depositary Receipts (ADRs)

ADRs represent a specific number of foreign company shares issued by US banks. Since foreign companies find it difficult to directly list on major US exchanges, they often list through ADRs in OTC markets.

Key Differences Between OTC and Exchange Trading: Three Core Aspects

Is OTC a Synonym for Risk?

OTC trading is often labeled as “risky” due to the lack of centralized exchange regulation, but this perception is not entirely accurate.

Lack of Unified Regulation is a Double-Edged Sword

While it is true that OTC markets are loosely regulated, this does not mean they are completely uncontrolled. Honest and trustworthy brokers are subject to various levels of regulation and possess strict risk control systems. Investors’ primary task is to select regulated, compliant brokers, and understand key information such as licensing authorities, risk management capabilities, spreads, and liquidity conditions.

Trading Flexibility Brings Opportunities

The flexibility of OTC markets allows investors to:

• Access a wider range of investment products, including assets not covered by exchanges

• Customize trading plans, adjusting leverage and trade sizes according to personal risk preferences

• Obtain higher leverage multiples, achieving leverage levels difficult in traditional markets

• Trade a more diverse array of derivatives and contract products

Real Risks Faced in OTC Trading

1. Liquidity Shortage — Some OTC securities have low trading volumes, making it difficult to find buyers or sellers, and prices may deviate from market value.

2. Information Asymmetry — Listed companies are required to disclose financial information regularly, whereas OTC companies have lower disclosure requirements, making information harder to obtain.

3. Market Volatility Risk — OTC markets may experience more intense price swings, especially for small stocks with limited liquidity.

4. Leverage Traps — High leverage is a double-edged sword; if the market moves unfavorably, accounts can quickly incur losses or be liquidated.

5. Fraud Risk — The loosely regulated environment may harbor dishonest brokers; investors need to stay vigilant.

Main Reasons Investors Choose OTC Trading

✔ Broader Investment Options — OTC markets open doors to investments unavailable on exchanges, including derivatives, binary options, spread contracts, forex, and more.

✔ Greater Trading Freedom — No uniform product specifications, allowing investors to tailor trading plans flexibly.

✔ More Flexible Leverage — Compared to traditional markets’ leverage restrictions, OTC markets offer multiple leverage options, amplifying gains but requiring cautious use.

✔ Lower Entry Barriers — Some OTC products have low minimum investment amounts, making it easier for small investors to participate.

Disadvantages of OTC Trading That Cannot Be Ignored

❌ Loose Regulatory Environment — Lack of unified standards, lower transparency, and weaker legal protections compared to exchanges, leaving room for fraud.

❌ Liquidity Risks — Smaller trading volumes may lead to difficulties in executing trades promptly or at desirable prices.

❌ Imperfect Price Discovery — Absence of a centralized bidding mechanism can cause price distortions, with significant differences in quotes between buyers and sellers.

❌ Difficulty in Information Access — Unlike listed companies with mandatory disclosures, OTC firms have lighter disclosure obligations, requiring investors to conduct in-depth research.

❌ High Leverage Risks — While offering flexibility, many investors overuse leverage without sufficient knowledge, leading to substantial losses.

Key Recommendations for Staying Safe in OTC Trading

If investors decide to participate in OTC trading, they should focus on the following points:

• Choose Regulated Brokers — Prioritize platforms recognized and supervised by reputable financial regulators (e.g., ASIC, FCA).

• Understand Trading Terms — Deeply understand spreads, liquidity levels, withdrawal mechanisms, platform features, etc.

• Master Risk Management Tools — Use stop-loss, limit orders, and set reasonable position sizes and leverage multiples.

• Continuous Learning — Acquire sufficient investment knowledge and market understanding before trading; avoid blindly following trends.

• Be Cautious with High Leverage — Leverage can amplify gains but also risks; novice investors should use lower leverage.

The essence of OTC depends on how investors utilize it. With thorough understanding of risks, choosing legitimate platforms, and applying scientific strategies, OTC trading can be a beneficial supplement to an investment portfolio rather than an inevitable risk trap.