OTC trading definition

What is OTC trading?

Over-the-counter trading, or OTC trading, refers to a trade that is not made on a formal exchange. Instead, most OTC trades will be between two parties, and are often handled via a dealer network. OTC trading is less regulated than exchange-based trades, which creates a range of opportunities, but also some risks which you need to be aware of.

When you trade OTC with a trading provider, you'll usually see two prices listed: a single buy price, and a single sell price. This differs from on-exchange trading, where you will see multiple buy and sell prices from lots of different parties.

Pros and cons of OTC trading

Pros of OTC trading

The most popular OTC market is forex, where currencies are bought and sold via a network of banks, instead of on exchanges. This means that forex trading is decentralized and can take place 24 hours a day, rather than being tied to an exchange's open and close times.

Stocks and other financial instruments can also be traded OTC - this includes derivatives such as swaps and forward contracts.

OTC trading gives companies that don't meet stock exchange requirements the opportunity to raise capital, which can help fund expansion and growth. Shares that are traded OTC tend to be cheaper than those listed on a centralized exchange. As a result, you can buy a lot of shares for a small amount of capital.

OTC trades have greater flexibility when compared to their more regulated and standardized exchange-based counterparts. This means that you can create agreements that are specific to your trading goals.

Cons of OTC trading

The unregulated nature of OTC trading means that there is a higher risk of a counterparty defaulting on any given agreement. This is particularly true for swaps and forward contracts.

Trading stocks OTC can be considered risky as the companies do not need to supply as much information as exchange-listed companies do. This means that companies can often claim to be 'up and coming' which is not always the case.