How does the OTC market actually work? A comprehensive guide to understanding the true nature of over-the-counter trading

Why Investors Need to Understand the OTC Market

Many investors are troubled by a question: why are some promising companies not found on mainstream exchanges? The likely answer is that they are traded over-the-counter. OTC market (Over The Counter market) is not a niche area; rather, it is an essential part of the global financial system, with trading volumes far exceeding those of centralized exchanges.

The existence of OTC trading stems from the inherent limitations of traditional exchanges—high listing thresholds, complex approval processes, and strict disclosure requirements. Startups, small and medium-sized enterprises, and even some large corporations choose OTC trading to avoid excessive regulation. As a result, the OTC market offers a wider range of investment targets and more flexible trading methods, attracting increasing participation from institutional and individual investors.

What is the OTC Market? Core Operating Logic

OTC stands for Over The Counter, which simply means investors bypass centralized exchanges and trade directly through dispersed channels such as banks, brokerages, and electronic platforms. Unlike the public bidding process of exchanges, OTC markets adopt a negotiation-based pricing model between trading parties.

What does this imply? It means that the same stock can have different transaction prices—say, 100 yuan in the hands of Investor A and 105 yuan in Investor B. Price formation is controlled by the trading parties, not by market-wide auction.

OTC counterparties are highly diverse—banks, brokerages, corporations, or other individual investors. This decentralization leads to another characteristic of OTC markets: high information asymmetry. Savvy investors can leverage informational advantages to earn excess returns, while less informed investors may fall into traps.

What Types of Products Are Traded in the OTC Market?

Stocks: Unlisted stocks, delisted stocks, and shares of small and micro enterprises are the main products in OTC markets. Taiwan’s OTC market mainly features small to medium-sized, growth-oriented companies, which, despite their modest size, often have underestimated growth potential.

Bonds: Corporate bonds, municipal bonds, and other non-standardized bonds tend to have better liquidity in OTC markets. Compared to exchange-traded bonds, OTC bond trading volume is smaller but more diverse.

Derivatives: Options, futures, CFDs (Contracts for Difference), and other structured products are primarily traded OTC.

Commodities: Forex, precious metals, energy futures, and other commodities also hold significant shares in OTC trading.

Cryptocurrencies: Although there are dedicated crypto exchanges, large OTC transactions remain the preferred method for institutional investors to purchase substantial amounts of digital assets without impacting market prices.

How the Taiwan OTC Market Operates

Taiwan divides its stock market into two tiers: the Stock Exchange (listed companies) and the OTC Market (Gretai). The Taiwan OTC Market has established an OTC Index to reflect the overall performance of small and medium-sized stocks.

The government set up the OTC center to provide financing channels for startups. Companies that receive recommendations from at least two brokerage firms can list on the OTC market. If their performance improves or they turn profitable within six months, they may apply to upgrade to a mainboard listing. This system has indeed supported many unicorns but has also attracted a wide range of companies, some less reputable.

Taiwan OTC Market Trading Rules:

• Pre-market trading: 08:30-09:00; normal trading: 09:00-13:30; post-market pricing: 13:40-14:30
• Price matching: every 5 seconds
• Price limit: ±10% (same as listed stocks)
• Settlement cycle: T+2 (same as listed stocks)

This means that Taiwan’s OTC trading mechanism is largely similar to the main market, and retail investors face relatively low barriers to participation.

Comparison: Off-Exchange vs On-Exchange Trading — Seven Dimensions

This comparison highlights a core contradiction: OTC markets offer greater flexibility but lower transparency and liquidity.

Where Are the Investment Opportunities in the OTC Market?

Broader range of targets: OTC markets provide investment opportunities beyond exchanges. Many promising startups and industry newcomers seek early-stage capital support here.

Higher leverage potential: While on-exchange trading has leverage restrictions, OTC markets impose fewer limits, allowing experienced investors to amplify returns.

Flexible trading strategies: OTC markets enable both long and short positions, offering more diverse trading methods, especially for hedging.

Arbitrage opportunities: Due to information asymmetry, investors with better market intelligence can profit from informational advantages.

The Risks of OTC Market Cannot Be Ignored

Lack of unified regulation: This is the biggest issue. No standardized trading rules, no mandatory disclosure requirements, and no central clearing mechanism create opportunities for fraud. Some fake exchanges set traps to scam investors.

Liquidity risk: Certain OTC products are illiquid, leading to situations where investors cannot sell or are forced to accept poor prices.

Credit risk: Counterparties may default or disappear, and without a clearing system like exchanges, losses may be unrecoverable.

Price volatility: Some OTC stocks and derivatives can be highly volatile, especially susceptible to manipulation by market makers. Retail investors lacking information can easily become the “bagholders.”

False information traps: Malicious actors often spread false announcements or fabricate positive news to lure investors, causing herd-like crashes.

How to Trade Safely in the OTC Market

First, choose reputable brokers: Ensure they are regulated by authorities like ASIC (Australia), FCA (UK), etc., and hold recognized licenses. Legitimate platforms offer risk assessments, KYC procedures, complaint mechanisms, and other protections.

Second, stick to mature products: Avoid blindly chasing obscure assets. Forex, commodities, and mainstream cryptocurrencies tend to have better liquidity and transparent costs.

Third, thoroughly understand the products: Study spreads, liquidity, historical volatility, and other fundamental info. Don’t engage with what you don’t understand—this is the most important self-protection principle in OTC trading.

Fourth, control risks strictly: Use stop-loss and take-profit orders, set limit orders, and manage position sizes carefully. OTC markets are high-risk, so risk management is essential.

Fifth, beware of scams: Be highly cautious of “investment advisors” promising high returns, recommending “hot stocks,” or urging group investments—these are typical fraud schemes.

Summary: The OTC Market Is Both an Opportunity and a Risk

The OTC market indeed offers more investment opportunities and greater trading flexibility, but all of this depends on investors having sufficient knowledge and risk awareness. It’s not that OTC markets are inherently unsafe; rather, the safety depends on the choices investors make.

Choosing the right platform, the right products, and doing thorough research can turn OTC markets into a channel for excess returns. Conversely, reckless entry, misinformation, and high leverage can turn OTC markets into a nightmare of losses.

In an era of information overload and countless traps, the OTC market tests not luck but investors’ professionalism and risk consciousness.