OTC Markets

An over-the-counter (OTC) market is one where trades are arranged directly between two parties, usually through dealers, instead of on a central exchange with a public order book. Some of the largest markets in the world are OTC, including most of the currency, bond and swap markets. At the other end of the scale, many small and speculative stocks also trade OTC because they do not meet exchange listing standards.

How OTC markets work#

In an OTC market, dealers quote prices at which they are willing to buy and sell. Clients trade with those dealers by phone, chat or electronic platforms. There may be no single place where all prices are visible, and trades can be customised in size and terms.

Major OTC markets#

• Foreign exchange: the largest market in the world trades mainly OTC between banks, dealers and electronic platforms. See What Is Forex?.
• Bonds: most corporate and municipal bonds, and a large part of government bond trading, happen OTC. See Bond Trading.
• Derivatives: interest rate swaps, many currency forwards and other custom contracts. See Swaps Explained.
• OTC stocks: shares of companies not listed on a major exchange.

OTC stocks#

In the United States, OTC Markets Group operates tiers for stocks that trade off exchange:

Many OTC stocks are very low priced, thinly traded and have limited disclosure. They are a frequent target of pump and dump schemes. See Identifying Trading Scams.

Counterparty risk and reforms#

Because OTC trades are agreements between two parties, each side depends on the other to pay. During the 2008 financial crisis, uncertainty about who owed what in OTC derivatives markets spread panic. Since then, reforms in the US (the Dodd-Frank Act) and elsewhere require many standard OTC derivatives to be cleared through central counterparties, traded on regulated platforms and reported to trade repositories. See Market, Credit and Counterparty Risk and Clearing Houses and Central Counterparties.

Why OTC markets exist#

• Customisation: companies can hedge exact amounts and dates rather than standard contract sizes.
• Large trades: institutions can negotiate big blocks privately.
• Instruments that rarely trade: thousands of individual bonds trade too infrequently for a central order book.
• Access for smaller companies that cannot meet exchange listing requirements.

How to approach OTC instruments#

If you trade anything OTC, check three things first: who your counterparty is and how strong it is, how you would exit and at what likely cost, and what information is published about the asset. For forex, that means a well regulated broker. For OTC stocks, it means reading the company's filings, checking which tier it trades on and looking at real daily volume before buying.

Frequently asked questions#

What does over the counter mean in trading?#

It means trading directly between parties or through dealers, rather than on a centralised exchange.

Are OTC stocks risky?#

Often yes. Many have low liquidity, wide spreads and limited public information, and some are targets of manipulation.

Is forex traded OTC?#

Yes. Spot forex is traded over the counter through banks, dealers and electronic platforms; currency futures trade on exchanges.

Sources#

• U.S. Securities and Exchange Commission, Over the counter market
• Wikipedia, Over the counter (finance)