4. What is OTC?
Over-the-counter trading (OTC for short), also known as off-exchange trading, generally refers to trading activities not conducted on the central exchange, but through the “dealer network”. OTC transactions are conducted directly by the buyer and seller on a one-to-one basis, which normally does not require third-party supervision. In the financial market, there is a wide variety of underlying assets in trading, including securities, bonds, currencies, various commodities that all of which can be processed through OTC trading.
The OTC market is a virtual marketplace as a physical location is not necessarily required. As information technology advances, international dealing communication has evolved from using traditional telegram and telephone to adopting network systems to process all daily transactions. Brokers can request a price quote from other brokers or their clients via electronic trading platforms.
The Features of OTC Trading
Most importantly, floor trading is conducted on the central exchange, so that the trading information is fully disclosed and transparent in the market under regulation, with standardized contracts of the underlying assets and products. However, OTC trading is open for various trades that are not subject to the exchange regulated framework. Investors can trade non-standardized contracts including securities, commodities, foreign exchange by using Option, forward contracts, swaps, and other non-standardized financial derivatives products.
OTC trading is more flexible than central exchange trading. OTC trading activities do not need to follow the exchange’s trading clock as long as that specific market has liquidity. Therefore, the trading hours of many popular OTC products can be 24/7.
OTC Participants and Transactions
In addition, there are many participants in the OTC market, such as corporates, brokerage firms, investment companies, and investors of all sizes, without specific entry requirements or profiles. Having many diverse participants somehow enables the OTC market to promote its market liquidity and improve pricing transparency.
Related Article: What is market liquidity?
Therefore, the government and associated institutions do not directly supervise OTC transactions. In other words, it allows buyers and sellers to negotiate the trades directly with no obligation to disclose the details. Because of this, the problems of information asymmetry and opaque pricing may arise in trading. It is common that there is a price discrepancy between the final transaction price and the real market price. To protect public investors’ interests and ensure that OTC transactions will not create any market chaos, some countries and governments have set up certain regulatory agencies to implement rules and policies, ensuring orderly growth of the OTC market.
Dark Pool Trading
Dark pool trading, commonly known in the financial market, also belongs to OTC trading. It basically allows a number of large institutional investors to trade outside the central exchange in an anonymous way. Trading in dark pools not only reduces unfavorable price volatility but also facilitates trading by matching orders in a thinly-traded market, providing buyers and sellers with another way of liquidity.
Next Article: 5. Understanding the risks of investment correctly
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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.