Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via corporate-owned facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.
In the U.S., over-the-counter trading in stocks is carried out by market makers that make markets in OTCBB and Pink Sheets securities using inter-dealer quotation services such as Pink Quote (operated by Pink OTC Markets) and the OTC Bulletin Board (OTCBB). OTC stocks are not listed or traded on any stock exchange. Although stocks quoted on the OTCBB must comply with SEC reporting requirements, other OTC stocks, such as those stocks categorized as Pink Sheets securities, have no reporting requirements, while those stocks categorized as OTCQX have met alternative disclosure guidelines through Pink OTC Markets.
The OTC market presents investment opportunities for informed investors, but also has a high degree of risk. Many OTC issuers are small companies with limited operating histories or are economically distressed. Investments in legitimate OTC companies can often lead to the complete loss of the investment. Investors should avoid the OTC market unless they can afford a complete loss of their investment. Investors should never purchase any security without first evaluating the fundamentals of the company and carefully reviewing the financial statements, management background and other data. Investors who purchase securities based on a "hot tip" or the advice of chat room touts may often be disappointed.
OTC market statistics
Data provided by Pink Sheets:
Securities quoted exclusively on Pink Sheets - 5,019
Securities dually quoted on Pink Sheets and OTCBB - 3,445
Securities quoted exclusively on OTCBB - 130
Total OTC securities - 5,149
An over-the-counter contract is a bilateral contract in which two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the computer or the telephone. For derivatives, these agreements are usually governed by an International Swaps and Derivatives Association agreement.
This segment of the OTC market is occasionally referred to as the "Fourth Market."
The NYMEX has created a clearing mechanism for a slate of commonly traded OTC energy derivatives which allows counterparties of many bilateral OTC transactions to mutually agree to transfer the trade to ClearPort, the exchange's clearing house, thus eliminating credit and performance risk of the initial OTC transaction counterparts.
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