Deepening Understanding of Over-the-Counter Trading: Operation Logic, Market Characteristics, and Investment Traps

What is OTC Over-the-Counter Trading?

OTC (Over The Counter) refers to trading activities conducted outside of centralized markets. Compared to standardized transactions on securities exchanges, OTC trading is more flexible—buyers and sellers negotiate prices directly, with participants including banks, brokerages, corporations, and individual investors.

This type of market is also known as “over-the-counter trading,” “desk trading,” or “OTC market.” Participants are often small to medium-sized enterprises or startups that do not qualify for exchange listing, but some companies that meet listing criteria choose OTC trading to avoid the competitive pressure of public disclosure.

With the development of the internet and the expansion of international financial markets, the OTC market has rapidly grown. Investors’ demand for trading convenience and accessibility continues to rise, making OTC trading an important option for many investors.

Types of Products Traded in OTC Markets

OTC trading encompasses a much wider range of products than exchange trading, including:

Stocks: Besides listed stocks, OTC markets also offer stocks of small and medium-sized enterprises and startups that do not meet listing requirements or have not applied for listing.

Bonds: Due to large issuance volumes, diverse types, but infrequent trading, bonds are more suitable for OTC markets than exchange markets.

Derivatives: Contracts such as options, futures, and spread contracts can all be traded OTC.

Foreign Exchange: Currency trading on various platforms falls under OTC.

Cryptocurrencies: Popular cryptocurrencies can be traded OTC, allowing for large one-time purchases that are difficult to achieve in dedicated crypto markets.

How the Taiwan OTC Market Operates

Taiwan’s stock market is divided into two parts: the “Stock Exchange” and the “OTC Securities Exchange” (Gretai Center). The OTC index (Gretai Index), compiled by the Gretai Center, reflects the status of Taiwan’s OTC stock market. Many investors observe the OTC index to gauge the trend of small and medium-sized stocks.

This two-tier market structure aims to: listed companies must meet higher standards, but overly strict requirements can hinder startup development. To address this, the government established the Gretai Center, relaxing conditions to require only two or more broker recommendations. If a company achieves certain performance targets (such as improved profitability or financial health) within six months, it can apply to transfer to the main or OTC market.

However, lowering entry barriers also introduces issues. Besides genuinely promising companies, many less credible firms enter the market, and some unscrupulous brokers even recommend high-risk stocks to exploit investors, similar to the “pink sheet” trading depicted in the movie “The Wolf of Wall Street.” Therefore, investors need to carefully select quality targets and find reputable brokers.

Specific Process of OTC Trading

Step 1: Investors place orders through brokers. The process of buying and selling OTC stocks is identical to that of listed stocks.

Step 2: Orders are uploaded to the Gretai Center. Brokers upload orders to the Gretai Center’s Automated Trading System (ATS), which matches trades based on price priority and time priority. The overall process and technical rules are synchronized with the listed market, requiring no additional steps.

OTC Trading Schedule and Rules:

• Pre-market: 08:30–09:00
• Normal trading: 09:00–13:30
• After-hours pricing: 13:40–14:30
• Call auction frequency: every 5 seconds
• Price fluctuation limit: ±10% (same as listed stocks)

Settlement Mechanism: T+2 system, identical to listed stocks, with settlement completed two working days after the transaction.

The OTC market mainly consists of small and medium-sized, growth-oriented companies, with higher volatility but more attractive themes and growth potential. Due to better liquidity than the Emerging Stock Board and the same system as listed stocks, general investors face low participation barriers. However, smaller company sizes make them more susceptible to news and market sentiment, so investors should be aware of price fluctuation risks.

Core Differences Between On-Exchange and OTC Trading

Product Standards: On-exchange trades like bank gold buying/selling follow uniform standards; OTC trades like pawnshop transactions vary by shop, but offer more diverse products.

Trading Mode: On-exchange uses batch auctions, transparent but with limited profit margins; OTC involves negotiated deals, less transparency, where information is more important than capital.

Product Range: On-exchange requires standardization and large market scale, resulting in fewer products; OTC offers a wide variety to meet diverse needs.

Regulation and Liquidity: On-exchange is regulated by government-approved exchanges with high liquidity; OTC is operated by brokers with lower liquidity, and trades may not always get favorable prices.

Transparency: On-exchange trades are open with symmetric information; OTC trades may lack transparency, leading to information asymmetry. Experienced traders can earn excess returns, while inexperienced traders risk excess losses.

Trading Flexibility: On-exchange has strict risk controls, leverage, and short-selling restrictions; OTC offers fewer restrictions, enabling more flexible investment strategies.

Advantages of OTC Over-the-Counter Trading

✔️Broader Investment Options: OTC trading allows access to derivatives, binary options, contracts for difference (CFDs), forex, and more, providing a wide market spectrum.

✔️More Flexible Trading Methods: Products and trading methods are diverse and customizable according to investment goals.

✔️High Leverage Flexibility: Traditional markets have limited and heavily restricted leverage; OTC offers multiple leverage options, enabling higher leverage to amplify gains.

✔️Comprehensive Risk Management Tools: Modern OTC markets have optimized multi-layered safety structures similar to centralized markets. Many reputable brokers are regulated under well-known financial institutions, making trading more professional and safer for investors with sufficient knowledge.

Risks and Scams in OTC Over-the-Counter Trading

While OTC trading offers flexibility, risks should not be overlooked:

❌Lack of Unified Regulation: OTC markets lack uniform rules, transparency is limited, and legal regulation is relatively lenient. Many companies and securities that do not meet exchange standards can only trade OTC, creating opportunities for fraud. Fraudulent brokers and fake exchanges are rampant.

❌Low Liquidity: OTC securities have lower liquidity than centralized exchanges, making it difficult to execute trades at desired prices, risking inability to exit positions timely.

❌Market Volatility Risks: OTC investors often lack access to the transparent information provided by exchanges, facing higher market risks. Some products are highly volatile with minimal liquidity.

❌Counterparty Credit Risk: During price negotiations, sellers may offer different prices to different buyers. Investors face risks of counterparty default or dishonesty.

❌OTC Fraud Risks: There are malicious actors using false information to deceive investors. Fake trading platforms and brokers impersonate legitimate institutions, exaggerate returns, or hide risks to scam investors. This is especially common in cryptocurrencies and forex, with frequent scam cases.

Is OTC Over-the-Counter Trading Safe? How to Identify Fraud Risks

OTC trading is not entirely unsafe but does carry more risks than centralized exchange trading.

Ensuring broker safety is paramount. Reputable brokers should be under multiple layers of regulation with strong risk management. Investors should verify whether the broker holds a government-issued license.

Choose mature trading products. Understand spreads, liquidity, withdrawal rules, and other comprehensive information. Avoid obscure or illiquid products.

Identify OTC scam features:

• Promises of unreasonable high returns
• Requests for upfront payments
• Inability to provide clear regulatory or licensing information
• Lack of basic technical security measures on trading platforms
• Customer service unable to answer questions professionally
• Difficulties withdrawing funds or various obstacles

Seek protection measures from legitimate platforms. Compliant trading platforms should offer risk assessments, KYC procedures, complaint mechanisms, and other investor protection measures to reduce risks.

Be cautious with recommendations and brokers. Unscrupulous brokers may promote high-risk stocks; investors should conduct independent background checks and financial assessments, avoid blindly trusting recommendations, and be especially wary of pink sheets and other high-risk targets.

Conclusion

OTC over-the-counter trading offers flexibility and diverse options but also faces issues like insufficient regulation, higher risks, and scam dangers. For investors aiming to profit in OTC markets, choosing reputable brokers, understanding OTC market mechanisms, enhancing risk awareness, and learning to identify OTC scam traps are key to protecting their interests. Doing thorough research and exercising caution are essential to seize opportunities and avoid pitfalls in OTC trading.