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While traditional stock exchanges grab the headlines, OTC markets quietly facilitate the trading of various financial instruments, including stocks, bonds, and derivatives. We’ll get into the interesting world of OTC markets in this article, learning about its meaning, categories of traded securities, benefits, and drawbacks.
What is the OTC market?
Here, the OTC full form stands for over the counter markets. Individuals can use OTC markets to buy and sell financial products such as stocks, ETFs, bonds, commodities, and derivatives without going through traditional stock exchanges. OTC markets provide flexibility and confidentiality.
Unlike traditional exchanges, OTC trading happens electronically, without a central location, directly between two parties.
How does the OTC market work?
In the OTC market, companies that can’t meet the conditions for listing on bigger exchanges still get to sell their stocks to the public.
Broker-dealers in these networks quote prices for buying and selling, similar to how traditional exchanges work. Despite its informal setup, the OTC market serves as a default avenue for trading certain securities like corporate bonds.
Types of OTC markets
- OTCQX market: It is where you will find high-quality companies committed to providing information and transparency to their investors.
- OTCQB market: Companies here are usually in the early stages of growth.
- Pink market: The Pink Market is known for its flexibility, but it is also known for being a bit less regulated. So, when you dive into the Pink Market, you are in for a wilder ride compared to OTCQX and OTCQB.
Advantages and disadvantages of pros and cons of the OTC market
| Advantages and Disadvantages | Description |
| Pros | |
| Access to Various Securities | OTC provides access to securities like bonds, ADRs, and derivatives. |
| Easier Entry for Companies | Fewer regulations allow many companies to enter who can’t list elsewhere. |
| Earning Opportunities | Trade of low-cost, penny stocks can yield significant returns. |
| Cons | |
| Low Trade Liquidity | Low volume leads to delays in trades and wide bid-ask spreads. |
| Less Regulation | Results in less public information, outdated data, and possible fraud. |
| Volatile Price Movements | OTC stocks can have volatile price changes due to market or economic news. |
How to purchase a security in the OTC market?
- Look for a brokerage firm that lets you trade OTC stocks.
- Follow your chosen broker’s account opening process and deposit the amount of capital in your trading account.
- Identify the OTC stocks you want to buy and place buy orders for the chosen OTC stocks using the brokerage site. Specify the stock symbol, quantity, and OTC share price.
- Review and confirm your order details before finalising the purchase.
- Keep an eye on your OTC stock investments and make decisions carefully by understanding market developments.
- When you decide to sell your OTC stocks, use the same broker to place sell orders following a similar process.
Differences between the OTC market and stock exchanges
| Factors | OTC market | Stock exchanges |
| Trading | Online platform where people buy and sell stocks, bonds, and more directly with help from brokers. | Places with trading floors where people can buy and sell stocks, but most do it online. |
| Things traded | Stocks, bonds and digital currencies. | Mostly big company stocks, special investment funds, and ETFs. |
| Rules | Rules don’t have strict penalties as compared to stock exchanges. | They have strict rules, and the government watches closely. |
| Who can trade | Smaller and newer companies can join with fewer rules. | Larger and well-established companies are here. |
Over-the-counter exchange of India (OTCEI)
The Over-The-Counter Exchange of India (OTCEI) is a unique digital platform allowing smaller companies in India to raise capital.
Features of the OTCEI:
- Stocks on OTCEI are exclusive; they won’t be listed on other exchanges and vice versa.
- Companies need to have a minimum issued equity capital of 30 lakh rupees to be listed.
- Big companies with issued equity capital over 25 crore rupees cannot be listed here.
- Members should maintain a base capital of 4 lakh rupees to continue on the exchange.
Bottomline
The over-the-counter (OTC) market offers investors an alternative to traditional stock exchanges. While OTC networks lack the formality of centralised exchanges, they operate within SEBI-regulated guidelines.
FAQs
The OTC market is risky due to lower transparency and lesser reporting requirements. Though shares here are cheaper, they are more prone to speculation. Some OTC stocks may rise and shift to major exchanges, offering long-term gain possibilities.
Yes, the OTC market is legal in India, but it is subject to certain regulations and restrictions by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI). The OTC market is mainly used for trading derivatives, such as currency swaps and credit default swaps.
The OTC Exchange of India offers over-the-counter stocks for purchase via registered brokers. Although the risks are also significant, they are often affordable and have the potential to provide substantial profits if the business does well.
Because OTC securities have less transparency and more lenient reporting requirements, the market is often seen as risky. Your trading goals, risk tolerance, and the state of the market may all influence how good or bad OTC trading is.
The OTC trade life cycle is the process of trading securities without a central exchange. It involves the following stages: trade initiation, trade execution, trade capture, trade enrichment, trade validation, trade confirmation, trade settlement, and trade reporting.