OTC markets are a type of conventional market that is characterized by the elimination of financial intermediaries to trade financial assets. Within these markets you can trade all types of financial assets such as stocks, bonds, cryptocurrencies or derivative contracts (CFDs or swaps). Let's see the characteristics of this type of markets and what we have to take into account when operating in them.
What are OTC (Over the Counter) markets?
OTC (Over The Counter) markets are a type of market that are characterized by not having an intermediary when trading assets of a company outside the market. Therefore, They are operations that companies carry out directly with each other, without resorting to intermediaries such as the banking system itself or the stock market.
Although they are decentralized markets that do not involve the participation of third parties does not mean they are not supervised. After the great crisis of 2008, these types of markets are supervised to avoid financial overleverage and the possibility of taking greater risks. Furthermore, companies that participate in OTC markets They must issue periodic reports on their activity, both for its clients and for regulatory entities.
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How OTC Markets Work
OTC markets work in a different way than traditional markets. The transactions that take place within these markets are carried out between two parties, where buy and sell orders are traded over the counter through telephone calls which are recorded in order to preserve the security of the transactions. Within these markets all types of assets can be traded, from stocks, bonds, cryptocurrencies or derivative contracts (CFDs or swaps). It should be noted that these markets have certain risks given that the assets traded in them are not subject to specific rules by regulatory authorities. This means that in many cases these markets lack order books, which can sometimes lead to liquidity problems. However, these types of markets usually bring together a large trading volume since it represents great savings in transaction costs, since the charging of third parties to manage the operation is omitted.
Features of the Paxos OTC market. Source: Paxos.
Advantages and disadvantages of OTC markets
OTC markets offer us a number of advantages over traditional markets, but they also have their disadvantages. Among the advantages of OTC markets can include:
- Financing for companies that do not have sufficient capitalization power to be listed on regulated stock exchanges.
- Greater flexibility in the conditions of contracts and trading hours, given that trading hours are extended.
- Lower financing costs along with a wide variety of assets.
However, it also presents a series of disadvantages to take into account:
- Little transparency, since it is not required to present all the information on the operations.
- Low liquidity and a higher risk of default.
- Prices are not based on supply and demand, which means they are not usually public.
How to trade safely in OTC markets
As we have seen previously, since there is no supervisory body we expose ourselves to non-compliance by any of the parties involved in the operations. That is why we must know which OTC markets to operate in to avoid being scammed. Below we list a list of criteria to take into account When operating in OTC markets:
- Before operating in OTC markets, know the risks involved in trading in this type of markets.
- Choose brokers that have good regulation to reduce the risk of falling into possible irregularities or scams.
- Brokers with separate bank accounts are best suited for OTC trading. If they additionally have accounts in Europe, the better, to be able to have our funds at all times.
- It is very important that we can choose ourselves the leverage with which we want to operate.
- Choose brokers that have low spreads to allow us to execute orders at appropriate sales prices.
- Choose brokers that have customer service with physical headquarters in our country and that speak our language.