Understanding OTC: How Over-the-Counter Trading Becomes Another Gateway for Investors

Core Definitions and Market Roles of OTC

OTC stands for Over The Counter, known in Chinese as “off-market trading” or “over-the-counter trading.” Simply put, when investors find a company worth investing in but cannot find it on mainstream exchanges, OTC trading becomes an alternative channel. This is not conducted within formal securities exchanges but through banks, brokerages, phone, or electronic systems, where the two parties negotiate prices directly and complete the transaction.

Unlike centralized exchanges with unified bidding, OTC prices are entirely determined by buyers and sellers. The counterparties are diverse, including banks, securities firms, corporations, or individual investors. This flexibility attracts many companies that cannot or do not wish to be listed on exchanges, especially small to medium-sized enterprises and startups.

Why Companies Choose OTC Trading

Not all companies qualify for exchange listing, and some that do meet the criteria may proactively choose OTC trading. The main reason is to avoid excessive disclosure of information that could lead to competitive pressure. With the development of the internet, the OTC market has rapidly expanded, becoming a popular trading method for many investors.

Taiwan’s OTC market mainly consists of small to medium-sized, growth-oriented companies managed by the OTC Clearing Center. Companies only need to be recommended by more than two qualified brokerages to list, which is much less strict than the requirements for listing on the main or emerging markets. This relatively simple application process creates opportunities but also results in a mix of quality.

Main Product Types in OTC Trading

OTC products are far more diverse than those traded on exchanges. Besides traditional stocks and bonds, they include:

Stock Trading covers shares of unlisted small companies, especially startup stocks, which is the largest investment area in the OTC market.

Bond Trading is advantageous OTC due to large issuance volumes, diverse types, and infrequent trading.

Financial Derivatives include options, futures, and spread contracts.

Foreign Exchange involves currency trading on various platforms.

Cryptocurrencies can be purchased in large amounts OTC, which is often difficult to achieve on dedicated crypto exchanges.

The non-standardized nature of OTC trading makes the products highly diverse; nearly any financial instrument can be negotiated and traded here.

Operation Mechanism of Taiwan’s OTC Market

Taiwan’s stock market is divided into the “Securities Exchange” and the “OTC Clearing Center” systems. The OTC index (also called the OTC index) compiled by the OTC Clearing Center 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.

The OTC trading process in Taiwan is quite regulated. Investors place orders through brokerages, which are then uploaded to the OTC Clearing Center’s Automated Trading System (ATS). The system matches orders based on price priority and time priority, with technical rules synchronized with those of the main market.

Trading hours are set as pre-market 08:30–09:00, regular trading 09:00–13:30, and post-market pricing 13:40–14:30, with a call auction every 5 seconds. Price fluctuation limits are ±10%, identical to the main market. Additionally, OTC stocks follow a T+2 settlement system, with settlement completed two working days after the transaction.

Since OTC companies are required to comply with information disclosure regulations (including quarterly reports, annual reports, and major news), the market transparency is higher than that of the Emerging Market, providing investors with relatively sufficient information.

Key Differences Between OTC and On-Market Trading

Product Specifications: On-market trading offers standardized products, while OTC trading is non-standardized. For example, banks on the exchange have uniform services; pawnshops in OTC vary widely, but the product types are more abundant.

Trading Modes: On-market uses auction-based trading, which is transparent and relatively fair but offers limited profit margins. OTC involves negotiated trading, where buyers and sellers directly negotiate prices, making information more critical than capital.

Regulatory Intensity: On-market exchanges are government-approved and fully regulated. OTC markets are only partially regulated; some operate under formal regulation, while others may be set up by illegal entities for scams.

Liquidity: On-market exchanges, with proper regulation and large scale, attract international capital and have high liquidity. OTC trading generally has lower liquidity, which may lead to less favorable prices.

Transparency: On-market trading publicly discloses prices and volumes; OTC markets may not. The information gap can provide an advantage to those familiar with the rules but pose risks of excess losses to less informed investors.

Trading Flexibility: On-market has strict risk controls, with leverage and short-selling restrictions. OTC trading has fewer restrictions, allowing more flexible investment operations.

Advantages of OTC Trading

Broader Investment Options: OTC trading enables access to derivatives, contracts for difference (CFDs), foreign exchange, and more, expanding market choices.

More Flexible Trading Methods: Products and trading modes are more diverse, allowing investors to customize according to their goals.

High Leverage Flexibility: Compared to traditional markets with low leverage limits, OTC offers various options, enabling investors to amplify gains with higher leverage.

Safer Market Environment: Modern OTC markets have optimized and established multiple safety mechanisms similar to centralized markets. Professional brokers, authorized and regulated by reputable financial institutions, provide a more secure trading environment.

Risks Faced by OTC Trading

Regulatory Gaps: OTC markets lack unified regulations, with relatively lax laws and supervision, making it easier for scam brokers to operate. Companies and securities that do not meet exchange standards can only trade OTC.

Liquidity Risks: OTC securities generally have lower liquidity than centralized exchanges, which may result in unfavorable prices or difficulty executing trades.

Market Volatility Risks: OTC investors often lack the transparent information available on centralized exchanges, facing higher risks from market fluctuations.

Counterparty Risks: Negotiated prices mean sellers may quote different prices to different buyers, and some products may have high volatility and low liquidity.

Scam Risks: Malicious actors may use false information to deceive investors into trading.

Key to Ensuring OTC Trading Safety

First, ensure the broker is reputable, regulated at various levels, and has strong risk management. Second, choose mature trading products, thoroughly understand spreads, liquidity, and other relevant information, and conduct comprehensive assessments.

Legitimate trading platforms offer investor protection measures such as risk assessments, KYC procedures, complaint mechanisms, and more, significantly reducing trading risks. With sufficient professional knowledge, investors can trade more confidently in OTC markets.

Summary

OTC means trading conducted off-market, providing opportunities for companies and investors unable to list on formal exchanges. Taiwan’s OTC market mainly features small to medium-sized enterprises, with higher volatility but attractive themes and growth potential. Due to better liquidity than the Emerging Market and the same system and listing standards, ordinary investors can participate in OTC stocks with relatively low barriers.

However, smaller company size means more susceptibility to news and capital flow impacts, so investors must be cautious of stock price volatility. Choosing reputable brokers, understanding the characteristics of traded products, and thoroughly assessing personal risk tolerance are essential for successful OTC market investments.