Over the counter (OTC) meaning
What is over-the-counter?
Over the counter (OTC) trades are networks where assets are traded through dealers rather than a formal exchange. They are often used to trade shares in companies that may be too small to be eligible for formal platforms such as the New York Stock Exchange (NYSE.)
In the US, transactions are usually arranged through the Over the Counter Bulletin Board, otherwise known as OTCBB for short. This is a service provided on a subscription basis by an independent, non-governmental organization called the Financial Industry Regulation Authority (FINRA.)
Generally, the stocks seen on the OTCBB tend to be volatile and illiquid, meaning that they are not traded as frequently as Microsoft or Apple shares might be over on the NYSE. As a result, there is normally a more significant divide between the bid price (the maximum buyers are willing to pay for shares,) and the ask price (the minimum sellers are willing to accept.)
How smaller firms use OTC
Over the counter markets are crucial for smaller businesses that still need to access financing from investors, even though they are not eligible for an initial public offering. Some firms might be put off by the expense of arranging an IPO, such as the one-off cost and annual fees associated with listing on the NYSE or Nasdaq. Thankfully for these companies, investors remain drawn to the OTC sector because of the potential for big returns if they make the right decisions.
There are still hurdles for businesses that aspire to have their stock traded over the counter. For starters, most networks will turn away so-called “penny stocks,” where shares cost less than $5 apiece.
Depending on the marketplace that businesses subscribe to, they may have to submit regular financial reports to the US Securities and Exchange Commission. Investors who opt for thee shares can have a better chance of inoculating themselves against the risk of fraud or price manipulation.
Bonds and derivatives are some of the other types of securities that trade in OTC markets, along with cryptocurrencies. Although there can be opportunities for investors to enjoy considerable growth in the price of the shares they hold, they can prove to be more volatile than those listed on formal exchanges – and shares can be more difficult to sell because of lower trading volumes.