OTC securities market - what is it, differences from the stock market
Most private investors quickly learn to trade on the exchange, but have little idea of the possibilities of over-the-counter exchanges.
However, in this market there are many interesting companies that do not want to go through the listing procedure and publicly place their securities.
OTC trading platforms are well suited for long-term investors who understand the intricacies of fundamental analysis.
What is the OTC Market?
The securities market can be divided into 2 categories: exchange and over-the-counter.
OTC market means an information platform where stocks and bonds that have not been listed on the stock exchange, as well as over-the-counter options, forwards and other instruments, are quoted.
In the USA, such a market is the OTC Market (from the English “over the counter” - behind the counter). OTC transactions on this site are concluded directly between the seller and the buyer without a central counterparty.
The main OTC market in Russia is called the RTS Board (from the English "board" - board). This site can be compared with an electronic bulletin board where sellers and buyers find each other.
This is a multifunctional information system for quoting securities not traded on the exchange, and other instruments. Access to quotes on the RTS Board is granted only to legal entities that have the status of professional participants. Individuals can make transactions in the OTC market only through brokers.
The following tools are on the RTS Board list:
- Shares covering all sectors of the Russian economy. Here are presented low liquid securities of small companies that are not traded on organized sites, as well as shares of leading Russian issuers. The list may also include foreign shares, Russian and foreign depositary receipts, shares of investment funds.
- Coins from precious metals. The list includes several hundred issues of investment and commemorative coins of gold and silver in accordance with the classification of the Bank of Russia.
- Fixed Income Instrument Sector. Both low-liquid bonds and securities traded on stock exchanges are presented here.
- Money market tools. Using the terminal, you can process, confirm and conclude transactions in the interbank lending sector.
OTC transactions may take the form of a civil contract between seller and buyer. In this case, transactions with securities are no different from transactions with any other property.
An organized OTC securities market implies the existence of an electronic system for quoting stocks, bonds and other instruments. Here you can analyze the market demand and supply for a financial asset, which greatly facilitates the search for a counterparty. In this sense, electronic bulletin boards are similar to traditional exchanges.
OTC markets are characterized by the following features:
- No standardization. If the exchange trades in standard lots (for example, 10 or 100 shares), then on an over-the-counter platform, each participant puts up an application for the volume he needs. Questions regarding the size of the transaction are decided directly between the seller and the buyer.
- Targeting applications. On a classic site, bidders do not know with whom they are making a deal: the exchange is a buyer for sellers and a seller for buyers. When over-the-counter transactions take place, you can see which professional participant submitted the application.
- No listing of securities. In order for the shares or bonds to begin to be traded on the stock exchange, the issuer goes through a listing procedure, which presents rather stringent requirements for the company. On the OTC market, any certified broker can register a package of securities in the system.
- Quotes display indicative prices only. If you submit an application at the current price, there is no guarantee that the transaction will be completed in full. The exact parameters of the transaction must be agreed with the opposite side.
- The size of the commissions. OTC securities market implies a higher fee for the broker than traditional stock exchanges.
The selection of instruments on the OTC platforms is extremely wide. This gives the investor great opportunities to compile a portfolio of cheap stocks with unlimited growth potential.
Stock indices of medium and small capitalization companies most often show more impressive dynamics than the main stock indicators. To balance the portfolio, it can be supplemented with securities with high dividend yield.
However, investor risks when buying shares of small companies are also growing. They are associated with low liquidity of securities and the difficulty of their quick sale in the market.
This parameter determines how quickly you can buy or sell an asset with minimal overhead. Liquidity is determined by the spread between applications for the purchase and sale of securities. The larger the spread, the longer it will take to wait for the transaction at the desired price.
The size of spreads on various securities on the RTS Board is very different. For some shares, the difference between applications for purchase and sale is 1-5%, for others it is in the tens and hundreds of percent.
However, one should not forget that these are only indicative quotes. It is possible that the application proposed by the investor will immediately interest the potential counterparty.
OTC markets are not suitable for short-term speculation and medium-term investments due to low market liquidity and large intermediary commissions. Quotes on this market rarely change under the influence of current news or the geopolitical situation, like on an exchange. To a greater extent, they depend on changes in the fundamental indicators of the company itself.
Papers of small enterprises are suitable for long-term investment with a horizon of 3-5 years. Here, money is invested based on the growth of economic indicators of the company and the increase in its market share.
To buy or sell paper, an investor needs to call his broker and give him an appropriate trading order. Today, almost all the leading Russian brokerage companies are accredited in the RTS Board information system.
In order for the OTC transaction to be executed, the trader will put the submitted application into the RTS Plaza glass. The investor has to wait until one of the professional market participants executes the order in full.
Another option is to work through a voice broker. Such companies specialize in bringing counterparties to OTC transactions.
The advantage of such organizations is that they keep in touch with most professional members. This allows them to quickly find a seller or buyer at the best price. The voice broker communicates the deal to the investor. The latter calls his trader, who is obliged to accept the application, call the counterparty back and fix the deal.
Today, OTC markets occupy about half of the entire US stock market. In the electronic system OTC Market More than 10,000 companies trade with more than 100,000 transactions per day.
To obtain a higher status, OTC Market participants are registered with US supervisory financial authorities. The platform classifies issuers depending on the degree of risk:
- OTCQX - trustworthy organizations that provide official reports on their economic activities.
- OTCQB are small companies registered with the US Securities Commission.
- OTC Pink - unpredictable issuers.
- OTC Gray - companies that do not disclose any information about themselves.
In addition to stocks and bonds, depository receipts, shares in investment funds, warrants, etc. are traded on the OTC Market. In total, more than 16,000 financial instruments are represented on the market. To view information about an asset, just click on its ticker. In the window that opens, data on the dynamics of quotations of the instrument, general information about the issuer, news about the company will appear.
The OTC system publishes its line of indices, as any exchange does. There is a composite index, indicators of companies with high capitalization, dividends, US, Canadian and global firms, bank papers, etc. These data can be compared with the dynamics of the main US indices S&P 500 and Dow Jones.
OTC Market employs both individuals and legal entities. To buy or sell a financial asset, a private investor should contact a certified dealer. The intermediary will find the counterparty by including their commission in the transaction price.
Conclusions: Pros and Cons
The advantages of OTC sites include such factors:
- a wide range of financial instruments for investing;
- high potential profitability;
- the possibility of implementing various investment ideas;
- lack of restrictions on the volume of transactions.
- low liquidity of many issuers;
- large commissions of intermediaries;
- lack of company information;
- high volatility of financial instruments;
- bankruptcy risks, deterioration of the economic condition of the organization.
Risks of trading on over-the-counter trading floors are high enough, but with a correctly conducted fundamental analysis of the enterprise, they will pay off with a good profit.