Over-The-Counter (OTC) refers to a trade of securities that are not made on a formal exchange such as the New York Stock Exchange. The OTC trades are handled via a broker-dealer network that is contrasting to on an integrated business.
Usually, securities that cannot meet the listing requirements of the stock market exchange are traded through Over-The-Counter (OTC). The stock that is traded via regular exchanges is called listed stock, while a stock that is traded through OTC are called unlisted stock.
Not only small companies traded their equities via OTC, but some well-known large companies are also listed on the Over-The-Counter (OTC) network such as Bayer A.G., Nestle SA. Allianz SE, Roche Holding Ag, BASF SE, and Danone SA. The shares of American depository receipts (ADR’s) are often traded via OTC.
Over-The-Counter (OTC) market set functions some of the best illustrious networks such as the Venture Market (OTCQB), the Best Market (OTCQX), and the Pink Open Market. However, the OTC networks are not formal such as the New York Stock Exchange (NYSE), but still, they have eligibility requirements. For example, OTC Best Market Group (OTCQX) does not list companies going through bankruptcy or that sell the stock for less than five dollars, known as a penny stock.
The bonds, derivatives and ADRs are also traded via OTC network. Though the financier must take great attention when financing in more speculative Over-The-Counter (OTC) securities. The OTC trading is less regulated than formal exchanges which involve some risk that an investor needs to aware of. There are some pros and cons of OTC network that an investor must need to consider.
Pros:
- Fewer eligibility requirements on OTC network allows the entry of many small and large companies who cannot list on formal exchanges.
- Its provide access to securities not available on formal exchanges such as ADRs, bonds and derivatives.
- Through the trade of penny stock, speculative investors can generate a substantial return.
Cons:
- Due to low trading volume, OTC stock has less liquidity which leads to wide bid-ask spread and delay in finalizing the trade.
- Fewer regulations usually lead to the possibility of fraud and the chance of outdated information.
- Over-The-Counter (OTC) stocks are prone to make a volatile move on the release of economic data.