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Understanding OTC Markets

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We’re sure you will have come across the term “OTC Markets” at one time or another, and while it may sound like a simple concept, it can be a bit tricky to understand fully. If you have ever wondered about the meaning of the term, here’s our primer on the question of OTC markets.

Over The Counter markets, or OTC markets for short, are non-standardized secondary markets. Primary markets, for example, Stock Exchanges, operate in a strictly regulated system, where standard financial instruments are traded. Should you walk into any stock exchange in the world and buy a share in any of the companies listed there, then you would know exactly what you’re getting and who you’re getting this from, which would in this case be a share in a company. These are often referred to as organized markets, with all transactions taking place through a centralized, regulated market.

Over The Counter markets on the other hand are often referred to as decentralized markets, as there is no centralized regulated market as well as no standard agreements between the parties involved. Any transactions on OTC markets are made by direct agreement between two parties. The conditions of these agreements are down to the negotiations between these two parties, which are subject to the local regulators and not to a centralized regulatory oversight. OTC markets have a counterparty; this could be an investor, a broker, a liquidity provider. This counterparty is referred to as the “Market Maker”. Buyers or sellers of OTC securities contact the counterparty through their broker, and trades are made directly between them and the counterparty. Unlike centralized markets, the prices that a market maker sets are negotiable.

Unlike Stock Exchanges, for example, the decentralized OTC markets don’t have a physical address. You could visit the London Stock Exchange if you wanted to; it has a physical address. OTC markets are networks of participants. While these participants will have a physical address, the network doesn’t.

It’s important to make a distinction here between centralized and local regulatory oversight. While there is no central body to regulate the forex and CFD markets per se, brokers do have to comply with their local regulators. In the case of EuropeFX, the means complying with our CySEC regulations (Cyprus Securities and Exchange Commission). These regulations lay out in detail all the parameters and conditions that we need to adhere to in our relationship with our clients. The lack of a centralized regulator, however, does not mean that there is no supervision by local regulators.

The OTC markets used to be reserved for large hedge funds and banks. Advancements in technologies over the last few years have opened up the OTC markets to retail traders. Trading on the OTC markets has become so popular that these markets now account for over forty percent of all stock trades in the United States.

Main Differences Between the OTC and Main Markets

Advantages of OTC Markets

  • More flexibility in contract specifications
  • Lower-priced financial instruments
  • Lower trade capital requirements
  • Wide range of assets
  • Extended trading hours
  • Leveraged Products

Disadvantages of OTC Markets

  • Lower reporting requirements mean less transparency
  • Higher risk of defaults
  • Reduced liquidity

Key OTC Markets

Forex

The largest and most liquid financial market globally, with a daily trade volume in excess of six Trillion dollars .

Contracts For Difference

CFDs have gained popularity over the years, with multiple asset classes available as CFDs, including currencies, stocks, indices, commodities and even cryptocurrencies.

Cryptocurrencies

Cryptocurrencies are one of the fastest-growing sectors for OTC trading. Extreme price movements and volatility call for strong nerves and a sound risk management strategy.