What Is the OTC Market? How Over-the-Counter Trading Works

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An over-the-counter (OTC) market is a decentralized market in which two parties trade a security, currency, commodity or contract directly with each other, usually through a dealer network, instead of on a central exchange such as the New York Stock Exchange (NYSE) or Nasdaq. In OTC trading, there is no single venue where all orders meet. Prices are quoted by dealers or negotiated between the parties, and each trade is a bilateral agreement. Stocks of small and foreign companies, most bonds, many derivatives and nearly all currency trading happen this way.

What Is the OTC Market?

“Over the counter” originally meant buying directly from a merchant across a counter rather than through a formal marketplace. In finance, an OTC security has not gone through an exchange’s listing process and changes hands directly between a buyer and a seller.

The OTC market is not one place or one company but a collection of dealer networks, electronic quotation systems and private negotiations, used by broker-dealers, banks, asset managers, corporations and individual investors. Some segments are highly organized, such as the U.S. quotation system for OTC equities. Others, such as a custom interest rate swap between a bank and a corporation, may be two parties agreeing terms by phone or chat and signing a contract.

Three features define OTC trading wherever it occurs:

• Decentralization. No central venue collects every order. Liquidity is spread across many dealers.
• Bilateral trades. Each transaction is an agreement between two parties, with the price set by a dealer’s quote or by negotiation.
• Flexible terms. Size, settlement date and, for contracts, the payoff itself can be tailored, because there is no exchange imposing standard specifications.

“OTC” also describes the security itself: an OTC stock is quoted over the counter rather than listed on an exchange, and an OTC deal is a privately negotiated transaction, such as a block of shares or a derivatives contract, arranged away from an exchange.

How OTC Trading Works

Dealers and two-way prices

The core of most OTC markets is the dealer, often called a market maker in stocks. A dealer trades from its own inventory and publishes a two-way price: a bid (the price at which it will buy) and an ask, or offer (the price at which it will sell). The ask is higher than the bid, and the gap between them, the bid-ask spread, is the dealer’s compensation for holding inventory and taking risk.

In commodity and derivatives markets, the dealer quoting both sides is sometimes called the price-giver or price-maker, and the client who accepts the quote is the price-taker. Because a client asking for a quote does not usually reveal whether it wants to buy or sell, the dealer is pushed to quote a fair two-sided market.

This differs from an exchange auction, where buyers and sellers post orders into a central order book and the exchange matches them. On an exchange, many participants compete inside one book. In an OTC market, a buyer may need to compare several dealers’ quotes, and the price obtained depends partly on which dealers the buyer can reach.

How a trade gets done

For a U.S. retail investor buying an OTC stock, the process looks familiar on the surface. The investor enters an order with a broker, and the broker routes it to a market maker quoting that security or to an electronic OTC quotation system. The trade executes against a dealer’s quote rather than against an exchange’s order book.

For institutional trades and derivatives, the process is usually a request for quote. The client contacts one or more dealers, describes the instrument and size, receives prices and accepts one. The terms are confirmed in writing, and for derivatives they are typically governed by a master agreement between the two firms.

Worked example: what the spread costs

As a hypothetical example, suppose a small company’s shares are quoted OTC by two market makers:

• Dealer A: bid $0.84, ask $0.88
• Dealer B: bid $0.83, ask $0.90

The best available prices are Dealer A’s ask of $0.88 to buy and Dealer A’s bid of $0.84 to sell. An investor who buys 10,000 shares at $0.88 pays $8,800. If the investor sold immediately at the $0.84 bid, the proceeds would be $8,400, a $400 loss before any commissions, even though “the price” did not move.

The spread as a percentage of the midpoint is:

Percentage spread = (Ask − Bid) ÷ ((Ask + Bid) ÷ 2)

Here: ($0.88 − $0.84) ÷ $0.86 = about 4.7%.

For comparison, a heavily traded exchange-listed stock priced at $100 with a one-cent spread has a percentage spread of $0.01 ÷ $100 = 0.01%. The OTC investor has to earn roughly 4.7% just to break even on a round trip at the quoted prices, assuming the quotes hold. An order larger than the dealer’s displayed size might partly fill at a worse price.

Now suppose a few days later interest in the stock rises, and dealers raise their quotes to $0.93 bid and $0.97 ask. A later buyer pays more, and the earlier buyer could sell at $0.93. In a thinly traded security, a handful of orders can move quotes this way, which is the source of both the opportunity and the volatility associated with OTC stocks.

Settlement and counterparty risk

On an exchange with a central clearinghouse, the clearinghouse becomes the buyer to every seller and the seller to every buyer, guaranteeing performance. In a purely bilateral OTC trade, each party depends on the other to deliver cash or securities, or to make payments over the life of a contract. That exposure is counterparty risk: the risk that the other side defaults before the trade is completed or the contract matures.

How much counterparty risk exists depends on the market. U.S. OTC stock trades settle through the same clearing and settlement infrastructure as many listed trades, while a long-dated custom derivative between two firms can carry credit exposure for years. Parties to bilateral derivatives often manage this with collateral agreements.

A Short History of the OTC Market

OTC trading is older than stock exchanges. Securities traded directly between parties from the 17th century, before formal exchanges took hold, and a large OTC market for unlisted companies remained even after exchanges grew in the late 19th and early 20th centuries.

In the U.S., the National Association of Securities Dealers (NASD) was established in 1939 to regulate the OTC market. Before electronic systems, investors or their brokers had to phone several market makers to compare prices. There was no single price for a stock at any moment, which made trends hard to track and left room for dishonest dealing.

For more than a century, dealers’ quotes for unlisted securities were printed on pink-colored sheets, the origin of the Pink Sheets. In the late 1990s they moved to an electronic quotation system, and the business eventually became OTC Markets Group, which now runs the OTCQX, OTCQB and Pink Open Market tiers.

In 1971 the NASD launched an electronic quotation system for OTC stocks, the National Association of Securities Dealers Automated Quotations, or Nasdaq. Nasdaq later separated from the NASD and became a registered national securities exchange, and the NASD’s regulatory functions were consolidated into the Financial Industry Regulatory Authority (FINRA).

OTC Market vs. Exchange

OTC liquidity is not uniformly low: the foreign exchange market is OTC and is the largest, most liquid financial market in the world. Transparency also depends on the segment. U.S. OTC equity trades are reported under FINRA rules, while a custom swap between two institutions may never be publicly disclosed beyond regulatory reporting.

What Trades Over the Counter

OTC stocks and the U.S. tiers

According to FINRA statistics, more than 10,000 securities trade in U.S. over-the-counter markets. Most are quoted on one of three tiers operated by OTC Markets Group:

• OTCQX: the top tier, with the strictest financial standards and reporting requirements. It includes established U.S. companies that choose not to list on an exchange and many large foreign companies.
• OTCQB: also called the Venture Market, aimed at early-stage and developing companies. Its standards are lower than OTCQX but higher than the Pink tier.
• Pink Open Market: the successor to the Pink Sheets, with the fewest requirements. It includes many small, speculative companies, shell companies and firms that provide limited information.

Companies end up on OTC markets for different reasons. Some are too small to meet exchange listing standards. Some were delisted from an exchange after falling below its requirements or entering bankruptcy. Some are foreign companies that want U.S. investors without a full U.S. listing. The tier tells an investor something about the company’s disclosure, but not whether the business is sound.

Many OTC stocks are also penny stocks, a term generally used for low-priced shares of small companies. Low price and low trading volume together make these securities especially vulnerable to manipulation.

Foreign company shares and ADRs

OTC markets are a common route for U.S. investors to own foreign companies. Instead of dealing with currency conversion, foreign trading hours and an overseas broker, they can trade foreign shares in U.S. dollars during U.S. hours, often at lower commissions.

Many large foreign companies trade OTC in the U.S. as American depositary receipts (ADRs). An ADR is a certificate issued by a U.S. depositary bank that represents shares of a foreign company held by the bank. The investor gets economic exposure to the foreign shares without buying them on the home exchange.

For the issuer, a quotation on a tier such as OTCQX can widen its U.S. investor base, which may increase trading volume and narrow spreads. Some foreign companies choose OTC trading specifically to avoid the more demanding reporting and compliance requirements of a U.S. exchange listing and full SEC registration.

Bonds

Most corporate and municipal bonds trade over the counter. A single company may have dozens of bond issues outstanding with different coupons and maturities, and many of them trade infrequently. That fragmentation suits a dealer market better than a central order book. Investors buy and sell through dealers who quote prices for specific issues. In the U.S., FINRA requires dealers to report many corporate bond trades, which gives the market more post-trade transparency than its decentralized structure might suggest.

OTC derivatives

OTC derivatives are contracts negotiated directly between two parties, sometimes with a broker helping to arrange the trade. Because no exchange dictates the terms, each contract can be fitted to the parties’ exact hedging or investment needs: amount, dates, reference rate and payoff. Common types include:

• Forwards: agreements to buy or sell an asset at a set price on a future date. Unlike exchange-traded futures, a forward’s size and delivery date are whatever the parties agree.
• Swaps: contracts in which two parties exchange cash flows or assets over a period, such as fixed interest payments for floating ones.
• Exotic options: options with nonstandard features or payoffs, such as barrier options, which activate or expire when the underlying hits a level, and lookback options, whose payoff depends on the best price reached.

The cost of customization is credit risk. Without a central clearinghouse, each party is exposed to the other’s possible default. The 2008 financial crisis highlighted that exposure, and post-crisis reforms in the U.S. and other jurisdictions required many standardized swaps to be cleared through central counterparties and reported to regulators. Customized contracts that cannot be standardized still trade bilaterally.

The same logic explains why much wholesale electricity and natural gas trading happens OTC. Utilities, producers and large consumers often need contracts for a specific delivery point, period and load shape. Those bespoke terms are easier to agree bilaterally than to fit into a standardized exchange contract.

Forex

The foreign exchange market is the largest and most liquid financial market globally, and spot currency trading takes place over the counter, with banks and other dealers quoting currency pairs to each other and to clients. Trading runs 24 hours a day, five days a week, passing between financial centers such as London, New York and Tokyo.

The OTC structure allows any transaction size, but traders depend on their counterparty, typically their broker or bank. Retail forex has attracted significant fraud, which is why U.S. regulators warn investors to confirm that a forex dealer is properly registered.

Crypto OTC desks

Large cryptocurrency trades, in bitcoin or a stablecoin such as USDT, are often arranged through OTC desks. The buyer requests a quote for the full block and settles it bilaterally, avoiding the price impact of a large order on a public book, but takes on the desk’s counterparty and settlement risk.

Why the OTC Market Matters

OTC markets fill gaps that exchanges leave:

• Lower-cost capital raising. Lighter listing and reporting obligations make raising capital cheaper for small and emerging companies, some of which later grow enough to move up to an exchange.
• Block trading. Large buyers and sellers can negotiate one price for a big position instead of executing many small orders on a public book.
• Markets with no exchange equivalent. Spot forex, most bonds and custom derivatives depend on OTC structures to exist at all.

How the OTC Market Is Regulated

In the U.S., OTC securities markets are overseen by the Securities and Exchange Commission and FINRA. The SEC sets the regulatory framework, including disclosure rules for issuers and conduct rules for broker-dealers. FINRA, a self-regulatory organization, supervises the broker-dealers that quote and trade OTC securities, monitors trading, enforces its rules and handles disputes. FINRA regulates the brokers, not the companies whose shares are quoted.

A central piece of the framework is SEC Rule 15c2-11. It requires a broker-dealer, before publishing a quotation for an OTC security, to obtain and review specific information about the issuer, to confirm that the information is current and publicly available, and to have a reasonable basis to believe the information is accurate and comes from reliable sources. A broker-dealer that wants to start or resume quoting an OTC security must file Form 211 with FINRA to show it has complied.

Derivatives fall under different regulators depending on the product. Swaps are generally overseen by the Commodity Futures Trading Commission (CFTC), while security-based swaps fall under the SEC. Retail forex dealers in the U.S. are also subject to CFTC rules.

Limitations and Risks of the OTC Market

Liquidity and spreads

Many OTC stocks have few active buyers and sellers. A small number of trades can move the price sharply, spreads can be wide, and selling quickly may mean accepting a much lower price or finding no buyer at all. The quoted price may also depend on which market makers are active at that moment.

Limited information

Exchange-listed companies must meet detailed disclosure and governance standards. Many OTC companies provide far less, and some on the lowest tier provide little or none. Without audited financial statements, metrics such as earnings per share or the P/E ratio may be unavailable or unreliable, and estimating the company’s equity becomes guesswork.

Fraud and manipulation

Low prices, thin trading and limited information have long made parts of the OTC market a target for fraud, and pump-and-dump schemes have kept SEC enforcement busy for decades. Promoters buy a cheap, thinly traded stock, spread false or misleading claims through social media, newsletters or messaging apps, then sell as new buyers push the price higher, and the price collapses.

Fraud also extends to schemes sold as private, off-exchange opportunities. In one prosecuted case, a promoter raised money for “CoinDeal,” claiming technology assets were about to be acquired by wealthy buyers, citing contracts and partnerships, and promising repayment with interest if the deal failed. The sale never happened, investor money was diverted, including into cryptocurrency purchases, and in 2023 he pleaded guilty to defrauding more than 10,000 victims of over $55 million. The warning signs were high returns with little risk, unverifiable claims and an opportunity presented as exclusive.

How to Invest in OTC Securities

Many online brokers offer OTC stocks, but access is not uniform: some block low-priced or lowest-tier securities, charge higher commissions for OTC trades or require extra acknowledgments. Specialized brokers may offer broader access to international OTC markets or penny stocks, sometimes with higher fees, stricter account requirements or minimum trade sizes.

The practical steps are:

1. Confirm your broker supports the security and check what it charges for OTC orders.
2. Identify the tier. OTCQX, OTCQB and Pink carry different disclosure standards. A stock screener that covers OTC securities can filter by tier, price and volume.
3. Read the company’s filings. Look for audited financial statements and current reports, and treat missing or stale information as a substantial risk.
4. Check volume and the spread. Calculate the percentage spread and compare your order size to typical daily volume, so you know whether you could exit.
5. Use limit orders. In a thin market, a market order can fill far from the last trade; a limit order caps the price you pay or accept.
6. Verify claims independently with the named counterparties or official sources, and be wary of unsolicited tips.
7. Size the position for possible total loss so no single OTC holding can seriously damage your portfolio.

Distinctions Readers Often Confuse

OTC vs. Nasdaq. Nasdaq started as the NASD’s electronic quotation system for OTC stocks, which is why older sources call Nasdaq stocks “over the counter.” Today Nasdaq is an exchange with listing standards. A Nasdaq-listed stock is not an OTC stock.

OTC vs. secondary market. The secondary market is any market where investors trade existing securities with each other, as opposed to the primary market where issuers sell new securities. OTC trading and exchange trading are both secondary markets; OTC describes how the trading is organized, not when the security was issued.

OTC vs. “dark” or off-exchange trading of listed stocks. Listed stocks can also trade away from their exchange, through broker internalization or alternative trading systems. That off-exchange trading of listed shares is different from the OTC market for securities that have no exchange listing at all.

OTC charts vs. exchange charts. An OTC stock chart is built from fewer trades, so gaps, long flat stretches and sudden spikes are more likely, and a single trade can create a large candle. Charts for forex and other dealer-quoted instruments use a particular provider’s quotes, so two platforms can show slightly different prices for the same pair at the same moment.

“OTC” labels on trading apps. Some brokers and binary-options platforms mark certain assets “OTC,” often when the underlying market is closed. The label means the price comes from the provider’s own quotes rather than from an exchange, and the provider is your counterparty. Those prices can diverge from the main market, and the provider’s interests may run against yours.

The Bottom Line

OTC markets matter to investors buying small or foreign company stocks, most bonds, currencies and custom derivatives that never reach an exchange. Before trading an OTC stock, check its tier, read its filings, compare the spread and volume to your order size, and use limit orders. Thin trading, sparse disclosure and a long record of pump-and-dump fraud mean each position should be sized so a total loss would not seriously damage a portfolio.