Over-the-Counter (OTC) Markets: Trading and Securities

Over-the-counter (OTC) markets are decentralized venues where participants trade securities directly with one another or through broker-dealers instead of on centralized exchanges. OTC trading covers a wide range of instruments—including stocks, bonds, currencies, derivatives, and cryptocurrencies—and is characterized by greater flexibility and privacy but generally less transparency and regulation than exchange-traded markets.

Key takeaways

• OTC markets facilitate trading outside centralized exchanges via broker-dealer networks or direct counterparty arrangements.
• They provide access to smaller or foreign companies, bespoke derivatives, and alternative assets.
• Liquidity, transparency, and regulatory oversight are typically lower, increasing counterparty and fraud risk.
• U.S. OTC activity is largely organized through networks such as the OTC Markets Group, which provides pricing and quote services.

What trades OTC?

Securities and instruments commonly traded OTC include:
* Stocks of smaller or foreign companies (and some exchange-listed stocks that also trade OTC).
American Depositary Receipts (ADRs), especially those not listed on a national exchange.
Most corporate and government bonds.
Currencies via interbank networks.
Cryptocurrencies traded privately between parties.
* Complex derivatives (e.g., customized swaps) that are tailored to counterparties’ needs.

How OTC trading works

Unlike exchange trading—where orders appear in a public order book and market makers help match buyers and sellers—OTC trading is conducted through dealer networks or direct bilateral agreements. Two main OTC segments are:
* Customer market: investors buy and sell via broker-dealers who facilitate transactions.
* Interdealer market: broker-dealers quote prices to each other to manage inventory and risk.

Broker-dealers collect and publish quotes, and trading is executed by negotiating price and terms. In the U.S., the OTC Markets Group is a major network that connects broker-dealers and publishes data for thousands of OTC securities.

Market tiers

OTC securities are often grouped into tiers based on reporting and disclosure standards:
* OTCQX — Top tier with higher financial and governance standards and current disclosure requirements.
OTCQB — Venture/early-stage companies that meet minimum reporting and verification standards.
OTC Pink — Lowest tier with minimal reporting requirements; it includes a mix of legitimate small issuers and higher-risk or distressed entities. (Note: tier names and structures can evolve over time.)

How to trade OTC securities

Steps to trade in OTC markets are similar to exchange trading but require extra caution:
1. Choose a broker that provides OTC access and transparent execution.
2. Research the security thoroughly—review available disclosures, financials, and liquidity.
3. Place orders carefully—use limit orders, consider smaller position sizes, and be mindful of wider bid-ask spreads and potential difficulty exiting positions.

Advantages and risks

Advantages:
* Access to smaller, foreign, or otherwise unavailable securities.
Potential for high upside if undervalued companies succeed.
Greater flexibility and customization for derivatives and private deals.
* More privacy for large or sensitive transactions.

Risks:
* Lower regulation and disclosure can attract fraud or poor-quality issuers.
Limited liquidity and fewer market participants can produce wide spreads and price volatility.
Less price transparency and harder execution—exiting positions can be difficult.
* Counterparty risk—possibility that the other party fails to fulfill its side of the trade.

Regulation and oversight

OTC markets are not unregulated. Key oversight mechanisms include:
* Securities and Exchange Commission (SEC): enforces rules against fraud and market manipulation and requires broker-dealers to ensure sufficient public information exists before publishing quotes for certain securities. Some OTC issuers report directly to the SEC depending on their tier and status.
Financial Industry Regulatory Authority (FINRA): regulates broker-dealers, monitors trading activity, and handles trade reporting and disputes.
Commodity Futures Trading Commission (CFTC): oversees certain OTC derivatives and currency transactions.

Bottom line

OTC markets expand investment choices—offering access to niche securities and customizable contracts—but these benefits come with increased complexity and risk. Investors should thoroughly research OTC issuers, use reputable brokers, and be prepared for lower liquidity, wider spreads, and reduced regulatory protections compared with national exchanges.