Just as there is the stock market, there is also the over-the-counter market: what is known as the OTC market, Over the Counter. There are many transactions that take place outside of organized markets; the OTC market is one of those experiences.
OTC markets are widely used by companies to move their shares and by investors to acquire them. Also, it is a good place for small investors and traders to take their first steps.
For these reasons, today we are going to tell you about the definition of the OTC market, we will see its characteristics and we will analyze the benefits and risks of operating in a market of this type. In the end, you will fully understand what an OTC market is. Let's see it.
What is the OTC market?
The OTC market is the market in which different financial instruments are traded, directly between the parties, without intermediaries, and outside the regulated markets.
The acronym OTC stands for Over the Counter, that is, on the counter, which refers to a direct transaction between the seller and the buyer. The OTC market is a financial market outside of the stock market. In turn, it is also known as the over-the-counter market or custom contract market.
According to information from the Forbes portal, the OTC market consists of a network of distributors and brokers, generally connected by computer means, in which shares that are not listed on the stock market, and other financial instruments are sold.
OTC stock works through unregulated agreements between the parties, so it is a good option for individuals who are entering the trading business and do not have a sufficient amount of capital to enter the stock market. For this reason, there are many OTC market participants, from SMEs to large companies, brokers, agencies, and banks.
What financial derivatives move in the OTC market?
In the OTC markets, you can buy and sell shares, bonds, and credit derivatives as in any stock market, but it also allows access to some financial derivatives that may be left out of traditional markets. Some of the most important are the following:
In the OTC market, you can buy cryptocurrencies. Whether Ethereum, ATOM, or Bitcoin, much of the digital currency trading takes place in the OTC market.
In the OTC market, contracts called Futures or Forwards are carried out, which are agreements between two parties to transact assets at a specific price on a near date.
Financial derivatives whose value depends on another, are known as swaps, and are transacted, generally, in the form of payment exchanges with fixed-income interest for variable-income interest, and are agreements that are made in the OTC market.
All national currency exchanges, since they do not take place in a centralized market, belong to the OTC market. What is known as Forex trading, is an active market 24 hours a day, 7 days a week, and is an over-the-counter market.
You see! Every time you change money or carry out a cryptocurrency transaction, you are operating in the OTC market. It's a bit closer than it seemed at first glance, isn't it?
What are the characteristics of OTC markets?
OTC markets do not have the same characteristics as the stock market. Being an unregulated financial market, it has its own aspects that set it apart from others.
The characteristics of the OTC markets are the following:
They lack a physical location, unlike the stock market.
Transactions are carried out through the Internet or direct communication, therefore, the OTC market hours are whatever, the one in which the negotiation is carried out.
Traders, known as market makers, are the ones who set the buy and sell prices.
Since it is a bilateral trading market, prices vary as a result of counter offers.
Assets in OTC markets tend to have high volatility.
OTC markets have existed for a long time, although there are portals where it is proposed that they exist since the 2000s. The truth is that they had a rise in popularity after the real estate crisis of 2008 in the United States, but the economic literature records their existence since the 1980s.
We have said that transactions in OTC markets are without intermediaries. This is correct, but it does not mean that nobody supports the exchange processes. In the absence of a governing house and distributor of the shares, as happens in the stock market, in the OTC markets there are brokers and agencies that help with the transaction, but as contractors, and not as parties to the negotiation. According to the BBVA portal, this generates two types of transactions:
Bilateral negotiation. It is one in which the operators or market makers publish their sales prices and carry out the transaction.
multilateral negotiation. The transaction is handled by an intermediary who executes it. Clearly, their work involves a cost, but it is less than the stock market.
What are the advantages and disadvantages of the OTC market?
Obviously, the OTC market has risks and benefits, generated above all by its deregulated nature. On the side of the advantages of the OTC market, we find the following:
Fewer regulations and transaction fees.
High performance and profitability.
Wide range of financial instruments.
Low capital entry barriers.
But the same thing that generates advantages, is what generates disadvantages. The risks of the OTC market are:
The lack of regulations generates greater insecurity and less trust.
Instability and volatility, when entering the financial market the price is something public, but in the OTC markets, as they are set by the parties, high-value manipulation is possible. Given their lack of control, there are those who believe that the OTC markets are manipulated by the big competitors within.
Lack of transparency since the privacy of the transactions can generate control difficulties.
High counterparty risks, as it is more likely to encounter fraudulent companies or shareholders.