What are OTC markets?

What is the difference between a regular listed exchange and an OTC market?

Regulation

Formal listed exchanges are regulated by specific governing bodies. For example, in Australia, listed exchanges are regulated by the Australian Securities and Investment Commission (ASIC), and in the US, they’re regulated by the Securities and Exchange Commission (SEC).

OTC markets are not regulated in the same way, so they operate with fewer rules.
 

The role of market makers

Regular listed exchanges are made up of buyers and sellers (either institutional investors or individual investors). So when you buy listed securities, you’ll be trading with other market participants.

OTC markets are made up of a large number of market makers who provide bid and offer prices on tradeable securities. When you buy or sell OTC securities, you’ll be trading with one of these market makers.

Price drivers and transparency

Listed exchanges are known as order-driven markets, meaning that orders of both buyers and sellers are visible to all market participants, including the quantity of stock available at that price. This means order-driven markets are generally more transparent than quote-driven markets.

OTC markets are known as quote-driven markets. Each market marker provides bid and offer quotes on a range of instruments and all trades are executed via these market markers. This means you won’t see the full depth of price and volume for other investors the way you would on a regular exchange. You’ll only see the market makers’ quotes, meaning these markets are naturally less transparent.
 

What are some of the risks of OTC markets?

• Some securities on OTC markets can be fairly illiquid, meaning even if you enter a position, you may have difficulty exiting at a fair price. This can also add to price volatility.
• Due to the illiquid nature of some OTC stocks and the pricing regulations of market makers (who are allowed to execute orders at any price), it’s prudent to consider a limit price on all orders.
   

What can you trade on an OTC market?

Institutional investors use OTC markets to trade instruments such as bonds, currencies and commodities. Retail investors will most commonly trade on US over-the-counter markets facilitated by OTC Markets Group. US OTC equities are broken into three categories which range in transparency: OTCQX, OTCQB & Pink sheets.

The types of companies listed on these exchanges can include:

• growth companies that don’t meet the listing requirements of a higher exchange
• secondary listings of foreign stocks that don’t wish to register with the securities exchange commission (SEC)
• Relatively unregulated companies with a higher risk profile (investors should thoroughly investigate these before making a decision).
   

How do I trade OTC securities?

1. If you want to trade US over-the-counter securities through CommSec International, you’ll need a CommSec international account.
2. Once the account is established, you’ll need to fund your account in the local currency that the stock settles.
3. Once the funds have arrived (generally 24–48 hours) you can call one of CommSec’s dealers on 1300 361 170 to execute your order.