What is OTC Market (over-the-counter)
OTC is an acronym for over-the-counter. It entails trading on a decentralized marketplace. The opposite of the OTC market is the exchange trading market, which involves centralized exchange.
In OTC trading, financial instruments such as stocks tend to be purchased via a broker-dealer on phone, email, or other computerized networks. The OTC market encompasses companies such as:
- penny stocks
- those filing for bankruptcy
- entities that don’t meet the set market capitalization standards
OTC trading is not subject to stringent regulations. In fact, the companies don’t have to disclose their information to the public. Besides, OTC stocks tend to be unpredictable and highly volatile.
OTC trading usually take place on OTC Markets, a platform with a network of broker-dealers. Part of this structure is the OTC Link, which acts as a FINRA-recognized trading system and broker-dealer.
OTC Market Trading Hours
The OTC Link usually operates between Monday and Friday from 6 AM to 5 PM ET. However, the platform is usually closed during the major holidays such as Christmas, Thanksgiving Day, Memorial Day, and Independence Day.
Besides, if the Christmas Eve, day before Independence Day, or the day after Thanksgiving fall on a weekday, the platform will close at 2 PM ET.
OTC stocks in the US have pre-market hours that start at 6AM and end at 9:00AM when the regular session starts.
News Source for OTC Market
Companies in the OTC marketplace avail their financial reports and news releases via the OTC Disclosure and News Service. As for news distribution, the service is integrated with key media distribution platforms such as Business Wire, Accesswire, PR Newswire, and GlobeNewswire.
The incorporation enables the concurrent distribution of companies’ details to the global audience.
Types of OTC securities
There are four main types of OTC securities in the US, including:
- OTCQX - These are the highest quality OTC companies listed by OTC Markets. Companies that list in this class must have all documentation and commit to regular disclosures.
- OTCQB - These securities are designed for young companies that are in their growth phas. They must have audited financials and be in compliant with American securities. They must have a minimum bid price of $0.01.
- Pink markets - These firms have no minimum standards, and as we are going to see below, they can be highly risky. They are classified as showing current information, limited information, or no information.
- Grey market - Finally, there is the grey market, which are not quoted by broker dealers and have little information.
OTC Pink Market
OTC Pink, which is also referred to as Pink Open Market or pink sheets, is the least regulated tier of the OTC stocks. The OTC Markets group does not require much from the firms in this category.
However, just like the other OTC market tiers, the broker-dealers must be members of FINRA. The firms are not obliged to file with the Securities and Exchange Commission (SEC).
OTC Pink firms avail different levels of information to traders. As such, they are categorised based on the provided quantity and quality of information.
- Current information companies: These firms adhere to the stipulated international financial reporting standards (IFRS). Subsequently, their filings are available to the pubic via the OTC Disclosure and News Service.
- Limited information companies: Firms in this category do not follow the OTC Pink Basic Disclosure Guidelines. It also includes companies that face the risk of/have already declared bankruptcy.
- No information companies: These companies do not avail any form of disclosure to the public.
If you are interested in trading in OTC Pink companies, ensure that you have a high-risk tolerance. Besides, the marketplace encompasses a wide range of local and international firms such as shell companies, financially distressed firms, and penny stocks that may not avail crucial information to the public.
As such, ensure that you conduct your due diligence before trading in these entities.
How to trade in the OTC Market
A Broker member of FINRA
Start by opening a trading account with a broker who is a member of the Financial Industry Regulatory Authority (FINRA). At DTTW, our traders have access to companies in the OTC market.
Do your research (as always)
Conduct your due diligence on the interested security and company. The crucial details include the financials and news releases of the firm, as well as the trade data.
The Typer of Order
Define the type of order you want the broker-dealer to execute. It can either be a limit order or a market order.
Understand how the Broker works
The broker-dealer will start by executing the trade internally. If that is not possible, either by choice or based on the prevailing circumstances, the broker-dealer will try and execute it externally with another broker.
If the order is non-marketable, the broker dealer may have to adjust the quote via the OTC Link ATS. Subsequently, another broker-dealer may propose a trade deal for the order.
Report and settle the trade
Upon accepting the offer to trade, the broker-dealer has the responsibility to report, clear, and settle the trade. Confirmation of the trade has to involve the trader.
Pros and cons of trading OTC markets
There are several benefits of trading OTC stocks:
- Access to quality companies - At times, it is possible to trade quality foreign companies that are listed in their original countries. For example, a company can be listed in the FTSE 100 and have a tracking stock in the OTC.
- Good for day trading - OTC stocks are good for day trading because of their volatility.
Cons of OTC
- Low liquidity - These companies tend to have extremely low liquidity, making them quite risky.
- No information - Some OTC markets lack adequate information for traders to use when making decisions.
- Expensive - Because of low liquidity, OTC stocks can be quite expensive to trade because of wide spreads.
- Quality alternatives - There are better alternatives in main boards like NYSE and Nasdaq.
Is OTC safe?
OTC is a safe market to trade but it has significant risks, as we have mentioned above. Instead of trading and investing in OTC, we recommend focusing on quality companies and other assets that you can find information on.
OTC vs stock exchanges
OTC is a different ecosystem compared to major exchanges like NYSE and Nasdaq. The latter exchanges have higher standards than OTC stocks. This means that companies that are listed there must pass a tougher criteria. Also, they must maintain quality and regular disclosures in the market.
OTC trading is the opposite of exchange trading. The encompassed companies, which are not listed on any stock exchange, include penny stocks and firms filing for bankruptcy, among others.
Before engaging in OTC trading, ensure that you conduct your due diligence on the interested company. Besides, you need to have a high risk-tolerance to survive in this form of trading.