Definition
The investing term over-the-counter market refers to decentralized securities exchanges where dealers act as market makers and trades occur between investors. Bonds, stocks, as well as non-standard derivatives can be traded by investors on the over-the-counter (OTC) market.
Explanation
The over-the-counter market provides investors with a number of opportunities to purchase a variety of securities. While the larger exchanges (NASDAQ, NYSE, TSX) provide a robust and transparent place for investors to trade stocks of larger companies, the OTC marketplace caters to niche offerings, as well as several important securities.
The OTC marketplace is characterized by dealers making markets in securities. This means they provide bid-ask quotes and liquidity by matching buyers with sellers. OTC markets are deemed less transparent than stock exchanges. For example, bid-ask spreads are not openly published, which oftentimes results in larger spreads. Investors can contact dealers over the phone or electronically. The market is regulated by the Financial Industry Regulatory Authority, or FINRA.
Typically, common stocks that are traded on the over-the-counter market are oftentimes those of struggling companies or businesses that do not meet the high standards of larger exchanges. The entire market is organized around three properties:
OTCQX: includes domestic (U.S.) as well as global companies that meet the financial standards of the marketplace. Companies must also be current with respect to their financial disclosures to regulating bodies.
OTCQB: developing companies regulated by the Securities and Exchange Commission, the banking or insurance industry. Securities exchanged are typically microcap or penny stocks.
OTC Pink: formally known as Pink Sheets, this market includes the trading of a wide variety of securities through dealer-brokers. Disclosures may not be current, and the securities of these companies are oftentimes experiencing financial distress.
Bonds are not traded on a stock exchange and investors oftentimes trust dealers at investment banks to provide liquidity in the secondary bond market. Non-standard securities, such as derivatives, are also traded on the OTC market.
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