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.
Forex
The most popular OTC market is forex.
Forex trading also takes place in over-the-counter markets as transactions are executed outside of a centralized exchange.
This is what allows forex traders to trade 24 hours a day as trading isn’t limited by the market hours of a formal exchange such as the New York Stock Exchange.
Instead, traders are able to buy and sell currencies through a network directly connecting various banks, dealers, and brokers.
Stocks
Stocks of small companies, bonds, and other securities that aren’t traded over a formal exchange can be traded over the counter.
In over-the-counter markets, dealers, also known as market makers, buy and sell securities from their own inventories.
As such, if an investor wanted to buy or sell certain security, he would contact a dealer of the particular security and ask for an appropriate bid or ask price.
In the U.S., the OTC Bulletin Board (OTCBB) is a popular electronic inter-dealer quotation system through which over-the-counter securities are traded.
The OTCBB, and other inter-dealer quotation networks such as Pink Quote, are regulated by the Financial Industry Regulatory Authority (FINRA).
Trading stocks OTC can be considered risky as the companies do not need to supply as much information as exchange-listed companies do.