What is OTC trading? How to trade securities over-the-counter

OTC trading vs. DMA trading:  how market access works

There are two main ways to access the financial markets and place orders:

1. Over-the-Counter (OTC) 
2. Direct Market Access (DMA) 

Direct market access trading allows you to place orders directly with an exchange. It requires specialist software that connects you to an exchange and allows you to make trades directly with counterparties. These transactions are written directly into the exchange’s order book. 

Over-the-counter trading is different. Transactions aren’t carried out directly on an exchange, nor are they directly overseen by the exchange. Instead, you place orders through a broker. You access a broker’s services by telephone or electronically, i.e. over the internet via an online trading platform. Brokers are connected to an OTC network that provides access to a variety of tradable securities. 

The OTC Markets Group Inc. 

For example, the OTC Markets Group Inc. is an electronic quotation and trading system that brokers can connect to. This operator provides marketplaces for over 11,000 OTC securities. So, what you get is a system through which brokers connect to the OTC Markets Group Inc. platform. 

This creates a network of brokers that can offer securities to retail customers (aka you) via the OTC Markets Group Inc. platform. 

Even though you’re not trading directly via an exchange, OTC trading is still safe. Operators such as the OTC Markets Group Inc. are regulated by authorities like the Securities and Exchange Commission. Also, OTC securities are subject to reporting and regulatory standards. This isn’t always true, but, in general, OTC securities are overseen by financial regulators. 

OTC trading is safe, but it’s also true that varying degrees of regulatory oversight means certain securities could be riskier to trade than others. Again, this doesn’t mean OTC trading isn’t safe, it simply means that you need to consider additional risks that may not be a problem when you trade directly via an exchange. 

The three tiers of OTC securities 

The OTC market can be divided into three main categories. We can use the OTC Markets Group Inc. to outline the three tiers and explain the securities available in each one: 

Best market (OTCQX) 

Securities traded within this platform (i.e. tier) don’t sell for less than $5. This means you’re not trading penny stocks or stocks in companies going through bankruptcy. The stocks available in this market are typically from established companies or those listed on foreign exchanges. 

For example, if you’re in the UK and wanted to trade stocks in a company listed in Germany, you could do it through OTCQX. Given the stock price and status of the companies traded within this tier, the securities are subject to strict regulatory oversight. Also, the companies listed have to meet the highest reporting standards possible. 

Venture market (OTCQB) 

This is the OTC market where stocks in developing companies are traded. The stock price can be below $5, and the companies still have to report their financials to official regulators. These companies are still subject to regulatory oversight. However, the regulations aren’t as strict, and the companies can be seen as niche, recently listed start-ups or small companies. 

Pink open market 

The open market consists of companies that don’t have any reporting requirements and aren’t subject to regulatory oversight. It’s not accurate to call it the Wild West of OTC trading. However, a lot of the companies in this market are not established. This is seen as the riskiest market to trade OTC securities. 

How to trade over-the-counter 

You can trade a variety of OTC securities online. We’ve focused on stocks, but you can also trade the following securities over-the-counter: 

Derivatives 

Derivatives are securities that derive their value from an underlying asset. This means you’re not trading the asset, but a contract/agreement that derives its value from the asset. You can trade futures and forwards on the OTC market. 

Bonds 

Bonds aren’t traded on formal exchanges because they’re issued by banks. Because of this, they’re traded via broker-dealer networks, which means they are OTC securities. 

Foreign currency 

The foreign currency exchange market is OTC. Therefore, when you trade forex, you’re doing it via a decentralised currency exchange. 

Cryptocurrencies 

Cryptocurrency exchanges are over-the-counter markets. This is because there is no central point of authority. Exchanges facilitate peer-to-peer transactions. 

Pros and cons of OTC trading 

There are some benefits of trading over-the-counter and a few drawbacks. As with all types of trading, nothing is guaranteed. The orders you execute aren’t guaranteed to return a profit. Some of the more specific pros and cons are: 

The Pros of OTC trading 

• You can trade securities that aren’t available on exchanges, such as bonds and derivatives. 
• You can trade penny stocks/lower cost stocks that, although potentially more volatile than high-value stocks, could provide significant returns. 
• You can trade stocks in companies that can’t/don’t want to be listed because of the regulations governing major exchanges. 

The cons of OTC trading 

• There is usually lower liquidity in the OTC stocks market, which means it can be harder to complete buy/sell orders. 
• Stocks of lower value (such as penny stocks) can be highly volatile and tend to move more significantly in light of economic data. 
• Fewer regulations and reporting requirements, particularly in the Pink Open Market, create more unknowns. This can lead to more risk. 

Try OTC trading 

You can try over-the-counter trading at Saxo Bank. For example, you can buy or sell forex currency pairs via our platform. Our advice to novices wanting to try any type of trading is to create a free demo account. This gives you access to a virtual bankroll and live markets for 20 days. 

The demo should give you a feel for our platform and how the financial markets operate. Once you’re confident, you can verify your identity, make a deposit and start making live trades on forex, stocks, futures, commodities and more.