What Is The OTC Market? (2024)

The over-the-counter market—commonly known as the OTC market—is where securities that aren’t listed on the major exchanges are traded.

Stocks and bonds that trade on the OTC market are typically from smaller companies that don’t meet the requirements to be listed on a major exchange.

How Does the OTC Market Work?

The over-the-counter market refers to securities trading that takes place outside of the major exchanges. There are more than 12,000 securities traded on the OTC market, including stocks, exchange-traded funds (ETFs), bonds, commodities and derivatives.

Unlike traditional exchanges such as the New York Stock Exchange (NYSE) or the Nasdaq, there is no physical location associated with the OTC market. Rather, all trades occur electronically and directly between two parties in a decentralized market.

Even though OTC securities aren’t “listed” with the major exchanges, these companies can still sell their stocks to the public over the counter. To the average investor, buying stocks in the OTC market may appear no different than the same process for exchange-listed securities: Stocks are assigned a unique ticker symbol, and typically are available for trading via the major online brokers.

The OTC market is the default exchange for some securities, like corporate bonds. It’s also a viable alternative for companies that don’t meet or maintain the requirements—like number of shareholders or monthly trading volumes—to list their shares on the major exchanges.

Alternatively, some companies may opt to remain “unlisted” on the OTC market by choice, perhaps because they don’t want to pay the listing fees or be subject to an exchange’s reporting requirements.

Differences Between the OTC Market and Stock Exchanges

There are a few core differences between the OTC market and formal stock exchanges.

In addition to the decentralized nature of the OTC market, a key difference is the amount of information that companies make available to investors. When stocks are listed on formal exchanges, investors can typically access a great deal more information on them, including reports written by Wall Street analysts, company news and filings, and real-time trading data.

There is much less available information on stocks traded OTC. Less transparency and regulation means that the OTC market can be riskier for investors, and sometimes subject to fraud. What’s more, the quoted prices may not be as readily available—with less liquidity, these stocks are prone to big swings in prices.

For example, penny stocks are traded in the over-the-counter market, and are notorious for being highly risky and subject to scams and big losses.

That said, the OTC market is also home to many American Depository Receipts (ADRs), which let investors buy shares of foreign companies. The fact that ADRs are traded over the counter doesn’t make the companies riskier for investment purposes.

What Are the 3 OTC Markets?

Even though there are generally fewer rules associated with being unlisted, and companies aren’t required to provide the same type of information as they would if they were listed on a stock exchange, not all securities traded in the OTC market are deemed the same.

OTC Markets Group, the largest electronic marketplace for OTC securities, groups securities by tier based on the quality and quantity of information the companies report.

While these designations don’t speak to the investment merits of a particular company, they do indicate how much information is available. These three markets are:

• The best market (OTCQX). This OTC market includes well-established, reputable companies that meet high financial standards and other stringent reporting requirements.
• The venture market (OTCQB). The venture market is for young companies that are still developing and growing. The eligibility requirements for this market are more lenient than for the best market, though companies may not be in bankruptcy.
• The pink market. Commonly referred to as the pink sheets, this is by far the riskiest of the OTC markets. Companies traded in the pink market provide the least amount of information and fail to meet the reporting requirements set forth by the Securities and Exchange Commission (SEC). Also known as the open market, this category is home to most penny stocks, shell companies and companies that are in some sort of financial distress. As a result of the less-stringent criteria to be included and lack of quality control, these securities are subject to fraud and pose risks to investors.

There is one final market that’s even harder to access for most investors: The grey market. These securities aren’t even quoted by broker-dealers because of a lack of available financial information and regulatory compliance.

Is the OTC Market Safe?

The OTC market is generally considered to be pretty risky, given the more lenient reporting requirements and lower transparency associated with these securities.

Because many stocks that trade over the counter have a lower share price (including penny stocks), they’re ripe for speculation.

Some stocks in the OTC market eventually move up to become listed on the major exchanges, and the prospect of long-term investment gains can be appealing to potential investors. Meanwhile, other companies with OTC stocks are on the downtrend

As with any investment decision, it’s important to fully consider the pros and cons of investing in unlisted securities. Identifying which of the three OTC markets a stock is in can help guide your determination of a company’s relative investment risk—even though that information alone won’t help you decide if it’s a good investment opportunity. That’s why it’s still important to research the stocks and companies as much as possible, thoroughly vetting the available information.

Risks of OTC Stocks

Because OTC stocks have less liquidity than those that are listed on exchanges, along with a lower trading volume and bigger spreads between the bid price and ask price, they are subject to more volatility.

What’s more, with less publicly available information about the financials of the related company, investors must be comfortable with the inherently speculative nature of investing in this market.

Penny stocks and other OTC securities are readily available for trading with many of the online brokerages, these trades may be subject to higher fees or some restrictions. For example, some brokers may limit trading of OTC securities during the period surrounding the stock market open and close or require investors to place limit orders—which dictate an exact price for the trade to be executed—in lieu of market orders.

Finally, because of the highly speculative and higher risk backdrop of investing in OTC securities, it’s important to invest only an amount of money that you are comfortable losing.

While these stocks could experience rapid and outsized gains, they’re also prone to frauds—such as so-called “pump and dump” schemes in which people hype a penny stock to inflate the price and draw in more investors before selling, and sending the price plummeting.