Complete Analysis of the Over-the-Counter (OTC) Market: From Definition to Operating Mechanisms

What Exactly Is the OTC Market?

When investors discover promising companies but cannot find them on mainstream exchanges, over-the-counter (OTC) trading becomes an alternative. In simple terms, the OTC market is a platform where investors bypass centralized exchanges and directly buy and sell various assets through decentralized banks, brokerages, telephone systems, or electronic platforms. It is also known as “over-the-counter trading” or “off-exchange trading.”

Unlike the unified bidding mechanism of centralized exchanges, OTC market prices are negotiated directly between trading parties. The counterparties are highly diverse—potentially including banks, securities firms, corporations, or individual investors. Due to this decentralized nature, the OTC market has rapidly expanded in the internet age, becoming an indispensable part of the global financial system.

Participants and Types of Assets in the OTC Market

Who Trades in the OTC Market?

Companies that trade OTC generally fall into two categories: one, small to medium-sized enterprises or startups that do not meet listing qualifications; and two, companies that are eligible for listing but choose OTC trading to avoid the competitive pressure of excessive disclosure, preferring a more relaxed regulatory environment.

Because the entry barrier is relatively low, the OTC market attracts many investors who are not interested in traditional markets, as well as speculators and unscrupulous traders.

Assets Traded in the OTC Market

• Stocks: Besides listed stocks, also includes stocks of unlisted small or startup companies
• Bonds: Due to large issuance volumes, diverse types, but low trading frequency, OTC trading has advantages
• Financial Derivatives: Options, futures, swaps, etc.
• Foreign Exchange: Currency trading on various platforms falls under OTC scope
• Cryptocurrencies: OTC markets enable large one-time purchases of digital assets, which are difficult to achieve on formal exchanges

How the Taiwan OTC Market Operates

Taiwan’s stock market is divided into two tiers: the “Stock Exchange” and the “OTC Securities Exchange” (also called the OTC Market). The OTC index, compiled by the OTC Securities Exchange (also known as the OTC Index), reflects the overall condition of Taiwan’s OTC stock market. Many investors observe this index to gauge the trend of small and medium-sized stocks.

Why Are There Two Markets?

The government established the OTC Securities Exchange to resolve a contradiction: strict listing standards ensure market quality but also hinder the development of promising startups. Therefore, the OTC Securities Exchange relaxed application requirements—companies only need to be recommended by more than two qualified brokerages to list. If they show progress within six months (such as turning losses into profits or improving financial health), they can apply to transfer to the main or OTC markets.

However, this lenient mechanism also brings issues. Besides genuinely promising companies, many less credible firms enter, and some unscrupulous brokerages even recommend high-risk targets to exploit investors.

Specific OTC Trading Process

OTC Trading Hours and Rules

• Pre-market: 08:30–09:00
• Normal trading: 09:00–13:30
• After-hours pricing: 13:40–14:30
• Price matching interval: every 5 seconds
• Price fluctuation limit: ±10% (same as listed stocks)
• Settlement system: T+2 (identical to listed stocks)

The OTC market’s trading rules are consistent with those of the main market, including price limits, call auctions, matching, and trading hours. Companies are required to disclose information transparently, with higher transparency than the Emerging Stock Market, enabling investors to access sufficient information.

OTC Off-Exchange Trading vs On-Exchange Trading

7 Key Differences

Differences in Product Standards

This is similar to the contrast between banks and pawnshops. Banks (on-exchange) have uniform standards; each gold transaction is consistent. Pawnshops (off-exchange) evaluate items individually based on their condition. Pawnshops can trade a wider variety of goods, offering unique options.

Fundamental Difference in Trading Modes

On-exchange trading is transparent and relatively fair, but profit margins are limited. OTC markets are the opposite—buyers and sellers negotiate prices directly, and information is more critical than capital. Even if someone offers a higher price, it doesn’t guarantee a purchase, as the counterparty may have already agreed with someone else.

Regulatory and Platform Differences

On-exchange trading is approved and regulated by the government. OTC markets are operated by brokerages or online platforms, with only some being officially regulated. This creates opportunities for fraudsters to set up fake exchanges. Investors must choose government-approved, regulated platforms to ensure safety.

Liquidity and Trading Volume

Because of strict regulation and transparent information, on-exchange trading attracts international capital, resulting in much higher trading volume. OTC markets have lower volume and liquidity, making it harder for investors to execute trades at desired prices.

Advantages of OTC Off-Exchange Trading

✔️ More Investment Options: Access to derivatives, CFDs, forex, and more, with a broad market selection

✔️ More Flexible Trading: Diverse trading methods and product specifications, allowing tailored investment strategies

✔️ Higher Leverage: Compared to traditional markets’ low leverage limits, OTC trading offers various options to amplify gains with higher leverage

✔️ Enhanced Security Measures: Modern OTC markets implement multi-layered security, with many brokers authorized and regulated by reputable financial institutions, allowing investors to trade confidently with professional knowledge

Risks of OTC Off-Exchange Trading

❌ Lack of Unified Regulation: No standardized rules, limited transparency, and relatively lax laws and oversight lead to many fraudulent brokers operating. In contrast, listed companies must comply with strict regulations.

❌ Liquidity Risk: OTC securities have much lower liquidity than exchange-traded ones, making it difficult to execute trades at favorable prices

❌ Market Volatility Risk: Similar to stocks, OTC markets are affected by market fluctuations. Most OTC investors lack access to the transparent information available to exchange investors

❌ Counterparty Credit Risk: Without a unified market and rules, sellers may quote different prices to different buyers, exposing investors to counterparty default risk

❌ False Information Risk: Some malicious actors spread false information to deceive investors into trading

Is OTC Off-Exchange Trading Safe?

Lack of exchange regulation does not mean OTC trading is inherently unsafe—key is how to manage risks.

First Line of Defense: Choose a Safe Broker

Brokers should be regulated at various levels and have strong risk management. Reputable platforms typically offer investor protections, including risk assessments, KYC procedures, complaint mechanisms, etc.

Second Line of Defense: Select Mature Trading Instruments

Understand the spread, liquidity, withdrawal mechanisms, and other aspects of the assets. Well-established instruments like forex are relatively safer.

Third Line of Defense: Self-awareness of Risks

Recognize that OTC prices can be volatile, liquidity may be insufficient, and some assets carry higher risks. Exercise caution accordingly.

OTC Investment Recommendations

To succeed in OTC trading, investors should:

1. Thoroughly research broker backgrounds: Confirm regulatory licenses, experience, and reputation
2. Understand asset characteristics: Know spreads, liquidity, volatility, etc.
3. Develop risk management strategies: Set stop-loss points, diversify, control leverage
4. Monitor market information: OTC info gaps are large; gaining an informational edge is crucial
5. Start small: Practice with demo accounts, build experience before investing real funds

Summary

As an essential part of the global financial system, the OTC market offers flexibility and diversity that centralized exchanges cannot match. It’s not that OTC itself is unsafe; rather, it demands higher professionalism from investors. Choosing regulated brokers, understanding market rules, and being vigilant about risks are indispensable. For capable investors who conduct thorough research and risk management, OTC markets open more opportunities; but for inexperienced investors, caution or avoidance may be the wiser choice.