What is the OTC Market and How Does it Work? Beginner’s Guide
Over-the-counter trading refers to party-to-party exchanges that happen privately through extensive, decentralized networks. Companies trading on OTC markets range from basic penny stocks to household-name multinational conglomerates. Similarly, traders range from first-time investors to seasoned backers. All have enjoyed tremendous success participating in off-exchange markets.
As many well know, the New York Stock Exchange takes place in a centralized, physical location. In contrast, OTC markets don’t have a set location. Instead, they consist of networks that exist almost entirely online. The OTC Markets Group is the largest and best-known coterie of trading networks. It consists of three stock exchanges: OTC Pink, OTCQB, and OTCQX.
In the simplest terms, the OTC markets are “junior markets.” The companies on these markets are too small to qualify for listing on the big exchanges, like the NYSE or Nasdaq. Instead, these companies can opt for trade on a network owned by the OTC Markets Group.
Trading is peer-to-peer and private with prices generally kept unpublished. Traded products range from commodities to penny stocks. Additionally, there are derivative products like CDOs and CMOs. OTC markets have significantly fewer regulations than stock exchanges. This leaves traders to make deals and bilateral contracts as they see fit.
The popularity of over-the-counter trading has exploded in the past decade. Everyone can find value in these off-exchange trading networks. Traders range from amateur investors to accomplished business owners. Our OTC stock loans are about helping investors retain their well-earned portfolio diversity. At the same time, investors can access the liquidity needed to make further investments.
For now, let’s go into detail about the three marketplaces under the purview of the OTC Markets Groups: OTC Pink, OTCQB, and OTCQX.
Also known as the pink sheets, OTC Pink is the most open and unregulated tier of trading marketplaces. The OTC Markets Group places next to no hard and fast requirements for companies to list here. They only require obtaining quotes from a broker-dealer registered with the Financial Industry Regulatory Authority. Companies need not file with the SEC. Instead, they are free to provide as much or as little information about themselves as they desire.
The name comes from prices historically distributed on pink paper once per day. But OTC Pink trading – formally owned, operated, and facilitated by the OTC Markets Group – has grown significantly since those days. Some view over-the-counter trading as synonymous with pink sheets. However, there’s important nuance between the two.
All over-the-counter trading was once referred to as “pink sheet” trading. But the OTC Markets Group has worked to re-categorize those old pink sheets, refine them, and make distinctions between their three networks. The group reformed the pink sheets into the present-day OTC Pink, OTCQB, and OTCQX.
OTC Pink is a massive, open market network. It is free from regulation and influence from structured exchanges. But it’s also important to note the incredible amount of risk associated with OTC Pink. It’s hugely important to have a discerning eye or use a trustworthy FINRA-registered broker-dealer. This helps to avoid pump-and-dump scams and other kinds of fraud.
There are plenty of valuable companies operating on the pink sheets. International juggernaut Nestlé, for example, lists here. Banks often decline to make investments in companies listed here and in the OTCQB. However, at Easy Stock Loans we have found our niche helping the small business starting out here.
OTCQB is the next tier on the OTC Market Groups lineup. It is designed to host the “Venture Market.” The companies here are small yet growing. They are subject to a minimum set of standards to be eligible for trading as compared to the pink sheets. Fraud and shell corporations are perhaps not as rampant as in the pink sheets. However, the open nature and minimum transparency requirements still put investors on shaky ground. This is if they conduct trades without assiduity and good investment acumen.
To be listed, all companies must meet a minimum of a $0.01 bid price test. They also must undergo yearly verification to ensure legitimacy. A certain degree of company information must be available. This reassures investors at least of a company’s legal condition and financial solvency.
There’s still a certain degree of risk involved in the OTCQB. The OTCQB and the OTCQX marketplace have only attained Blue Sky status in roughly 30 states. There’s certainly more transparency present than in the pink sheets. However, traders should still be cautious. That being said, most companies report to the SEC or FDIC.
The OTCQX is the highest tier in the OTC Market Group. It hosts multinational corporations, blue chip stocks, and groups that ultimately must thoroughly prove their integrity to investors. Companies are subject to strict disclosure requirements. They also must hold sponsorship from a third-party financial adviser. And, they must fully comply with US securities laws. These protections fundamentally necessitate exclusion of penny stocks to provide protection for investors.
Listed companies undergo strict scrutiny. However, trades remain private and decentralized. Of the three marketplaces, OTCQX sees the least amount of risk. But, as with all investment trading, risk is still extant. It is the case that companies undergo verification similar to what they would face in a mainstream stock exchange. However, they’re still fundamentally speculative investments. The products being traded may still be of poor quality but not necessarily.
Despite the risk, many investors enjoy incredible success in the OTCQX. They find it strikes the balance between free and safe.
OTC Link ATS
OTC Link is not another marketplace. It’s a service owned and operated by the OTC Markets Group for companies and traders on each of the three networks.
OTC Link is actually more important for companies, rather than individual investors. These companies are looking to get traded in one of the OTC Market Group marketplaces. It’s a FINRA-certified quoting system, formally registered as an SEC-compliant Alternative Trading System.
Essentially, OTC Link acts as a first stop for any company looking to trade on an OTC Market Group network. Companies must obtain quotes from the system. Broker-dealers can use it as a means of publishing ask and bid prices. It also allows for trade negotiation and messaging.
Risks & Benefits of OTC Markets
In general, the OTC Markets Group networks abide by different standards than traditional exchanges. These standards primarily include fewer regulations though a greater degree of privacy than exchanges. Many traders enjoy this privacy and unstructured environment. However, it means there’s a considerable amount of risk involved in trading in any OTC market.
Ultimately, features of OTC markets are either positives or negatives. It depends on your individual perspective and attitude toward risk management.
OTC markets are considerably more open than mainstream options. As such, they allow for the free trade of securities between parties without outside interference. At the same time, this lack of regulation means traders are at a greater risk of fraud. This is in comparison to, say, trading on the New York Stock Exchange. It’s worth noting that companies on the OTC Markets Group platform don’t have to file with the SEC to be listed. However, most choose to do so anyway.
Traders are free to set their prices and broker deals on their own. When combined with the inherently private nature of the OTC markets, this means unfair deals can occur. There’s a certain level of counterparty risk in play. OTC markets are also quite volatile. They change rapidly in response to new economic atmospheres.
For example, mortgage-backed securities are subject to fluctuations in liquidity. This is due to their sensitivity to buyer presence. This holds true as well for products like collateralized debt obligations. Volatility leads to credit crunches if dealers withdraw in fear. If this sounds familiar, it may be because this was part of the 2007 financial crisis. The regulations in place to prevent this from happening again aren’t present in the freewheeling over-the-counter markets.
So, what’s the takeaway? Yes, there’s risk involved when trading over the OTC markets. It’s incredibly important to be aware of these possible risks. Through smart trading, smart lending, and patience, however, it’s possible to minimize risk. (Although, we admit, you can never eliminate it). Through this, it’s possible to achieve a respectable ROI. The high volatility can sometimes work in your favor, after all.
Get Started with OTC Stock Loans
So, where does Easy Stock Loans come into play? We strive to provide loans to the companies and investors that find their place in the OTC Markets Group network. Most banks shy away from lending to ventures they consider penny stocks or otherwise high risk. However, we seek out opportunity where others ignore it.
We offer non-recourse stock loans for those trading on these junior exchanges. Our mission is to help grow their portfolios – even for micro-cap stocks that big banks avoid. Our loans allow companies to invest capital into new ventures and make the investments necessary to grow.
If you’re ready to apply for lending, give us a call to speak with an agent. Each member of our team is knowledgeable and dedicated to helping you understand the loan process, no matter what questions you may have.