In-Depth Understanding of OTC Over-the-Counter Trading: Complete Guide to Meaning, Features, and Investment Strategies

What Does OTC Mean? Basic Concepts of Over-the-Counter Trading

OTC (Over The Counter) is the English abbreviation for “over-the-counter trading,” representing transactions where investors do not trade on centralized exchanges but instead buy and sell various financial products directly through dispersed channels—including banks, brokerages, telephone systems, or electronic platforms. In other words, OTC means bypassing traditional exchanges, with both parties negotiating and executing trades outside the formal trading venues.

This market is also known as “over-the-counter trading,” “OTC market,” or “unlisted market.” Unlike the unified bidding process of centralized exchanges, OTC transaction prices are entirely determined by mutual agreement between buyers and sellers. The counterparties are diverse—banks, securities firms, corporations, or individual investors—this flexibility being a core feature of OTC trading.

Why Choose OTC? Unique Attractions of Over-the-Counter Trading

Many companies cannot list on exchanges due to reasons such as insufficient size, difficulty meeting disclosure requirements, or strategic considerations to reduce competitive information leaks. These enterprises seek financing and trading opportunities in the OTC market. In recent years, with the development of the internet and increasing investor demand for trading convenience, the OTC market has continuously expanded, becoming an indispensable part of the global financial system.

Compared to on-exchange trading, OTC trading offers several advantages:

• Product Diversity: Not limited to standardized products; non-standardized derivatives can be traded
• Trading Flexibility: Trading methods, leverage, and contract terms can be customized
• Low Entry Barriers: Small and medium-sized enterprises and startups can access financing
• Extended Trading Hours: Certain products support 24-hour trading

However, this flexibility comes with costs—lower price transparency, relatively lax regulation, and higher trading risks.

What Assets Are Covered in OTC Trading?

The OTC market offers a much broader range of products than traditional exchanges:

Stocks: Besides officially listed stocks, the OTC stock market mainly consists of unlisted small and medium-sized enterprises and startups, which choose OTC for financing due to not meeting listing criteria or complex application processes.

Bonds: Due to large issuance volumes, diverse types, but lower trading frequency, bonds are more suited for OTC trading, allowing investors to find more customized bond products.

Derivatives and Contracts: Options, futures, CFDs, and other derivatives are actively traded in OTC markets.

Foreign Exchange: Currency trading on various platforms is essentially OTC trading.

Cryptocurrencies: Popular digital assets can be purchased in large amounts via OTC markets, a convenience difficult to achieve on dedicated crypto exchanges.

How Does OTC Trading Work? An Example from Taiwan

Taiwan’s stock market is divided into the “Taiwan Stock Exchange” (listed market) and the “OTC Market” (also called the “Emerging Stock Board” or “Gretai Market”). The latter is the formal name for OTC markets. The OTC index (also known as the Gretai Index) reflects the overall performance of Taiwan’s small and medium-sized stock market.

Trading Process:

First, investors place orders through brokerages, using the same procedures as for listed stocks, with no need for special features.

Second, the orders are transmitted to the Gretai Market’s automated matching system (ATS), which automatically pairs trades based on “price priority, time priority.” The entire mechanism operates synchronously with the listed market.

Key Trading Rules:

• Trading hours: Pre-market 08:30-09:00, regular trading 09:00-13:30, after-hours pricing 13:40-14:30
• Call auction interval: every 5 seconds
• Price fluctuation limit: ±10% (same as listed stocks)
• Settlement system: T+2 (same as listed stocks)

The OTC market’s trading rules are fully aligned with those of the listed market, including price limits, call auction mechanisms, matching methods, and daily trading hours. Additionally, OTC companies must comply with disclosure regulations (quarterly reports, annual reports, and major news), making transparency significantly higher than in the emerging stock market.

OTC vs. On-Exchange Trading: Seven Core Differences

Product Specification Differences: On-exchange trading is like buying bank gold bars—each institution’s products are uniform; OTC trading is like pawnshop transactions—each deal varies, but more varieties are available.

Trading Mode Differences: On-exchange trading is transparent and relatively fair but offers limited profit margins; OTC trading involves autonomous negotiation, where those with better information can gain advantages.

Product Diversity: On-exchange products require a certain market scale, limiting varieties; OTC products are more diverse, especially suitable for non-standardized financial instruments.

Regulation and Platforms: On-exchange trading is operated by government-approved exchanges with comprehensive regulation; OTC trading is run by brokerages, some regulated, some unregulated.

Transparency and Information: On-exchange markets are mandated to disclose trading details; OTC markets lack such requirements, creating information gaps. Skilled traders can earn excess profits, while unskilled traders may suffer losses.

Trading Volume and Liquidity: Due to effective regulation and abundant international capital, on-exchange markets have far superior liquidity compared to OTC.

Trading Flexibility: On-exchange trading has strict risk controls, with leverage and short-selling limited; OTC trading has fewer restrictions, offering greater leverage flexibility.

Advantages of OTC Trading

✔️ Wide Investment Options: OTC markets offer derivatives, binary options, CFDs, forex, and more, allowing investors access to asset classes unavailable in traditional markets.

✔️ Highly Flexible Trading: Trading methods and product specifications can be tailored to investment goals, free from standardization constraints.

✔️ Flexible Leverage Usage: Traditional markets have leverage restrictions; OTC markets provide more options, enabling investors to amplify potential returns with higher leverage.

✔️ Continuous Market Improvement: Modern OTC markets have established multiple safety mechanisms, approaching the security levels of centralized markets. Licensed brokers are authorized and regulated, providing professional trading services.

Risks of OTC Trading

❌ Regulatory Gaps: OTC markets lack unified regulations and strict transparency requirements, with a relatively loose legal framework, providing space for fraudulent brokers. Listed companies must follow strict rules; many non-compliant companies can only trade OTC.

❌ Lack of Liquidity: OTC securities have much lower liquidity than centralized exchanges, making it difficult for investors to execute trades at desired prices.

❌ Market Risks: Although OTC is affected by market fluctuations similar to stocks, investors find it harder to access transparent information from centralized exchanges, increasing decision-making risks.

❌ Counterparty Risks: Direct transactions mean one party may default or go bankrupt. Some products are riskier due to high volatility and low liquidity.

❌ Fraud Risks: There are malicious actors exploiting false information to deceive investors. Investors should be especially cautious.

How to Protect Yourself in OTC Trading?

OTC trading is not inherently unsafe, but it does carry higher risks compared to on-exchange trading. Since OTC lacks unified market rules, buyers and sellers may quote different prices for different clients, exposing investors to counterparty credit risk, liquidity risk, and price volatility.

Key Measures for Safety:

First, choose reputable brokers: Brokers should be regulated at different levels and have strong risk management capabilities. Quality brokers offer investor protections such as risk assessments, KYC procedures, and complaint mechanisms.

Second, select mature trading instruments: Prioritize liquid products (e.g., major forex pairs), and understand spreads, liquidity, and other parameters thoroughly.

Third, conduct comprehensive due diligence: Before choosing a trading platform, check its regulatory licenses, customer reviews, withdrawal processes, and risk management tools to ensure it is under government regulation.

Fourth, set up risk management tools: Use stop-loss orders, negative balance protection, and other tools to establish a complete risk defense.

Fifth, develop market knowledge: Understand OTC market operation logic, pricing mechanisms, and common scams to enhance self-protection awareness.

Summary: OTC Over-the-Counter Trading Is Both Opportunity and Challenge

OTC simply means conducting financial transactions outside traditional exchanges. The OTC market opens the door for investors to access diverse assets, especially providing financing platforms for small and medium-sized enterprises and startups. Compared to on-exchange trading, OTC offers advantages such as product diversity, flexible trading, and low entry barriers.

However, this flexibility comes with costs—insufficient regulation, lower liquidity, and higher risks. Investors participating in OTC should fully understand its characteristics, carefully select brokers, implement proper risk management, and continuously improve their market knowledge and judgment. Only then can they capitalize on opportunities and avoid pitfalls in the OTC market.