Over-The-Counter (OTC) Market

An over-the-counter (OTC) market is a decentralized market in which market participants trade securities, commodities, currencies, or other financial instruments directly between two parties, without the need for a central exchange or broker. Unlike traditional exchanges, OTC markets do not have physical locations and instead, trading is conducted electronically. This makes them different from auction market systems, where trading is done through a central exchange with a physical location.

In an OTC market, dealers act as market-makers by quoting prices at which they will buy and sell a security, currency, or other financial products. This means that a trade can be executed between two participants in an OTC market without others being aware of the price at which the transaction was completed. In general, OTC markets are typically less transparent than exchanges and are also subject to fewer regulations. This can result in liquidity in the OTC market coming at a premium.

OTC markets are primarily used to trade bonds, currencies, derivatives, and structured products. They can also be used to trade equities, with examples such as the OTCQX, OTCQB, and OTC Pink marketplaces (previously the OTC Bulletin Board and Pink Sheets) in the U.S. Broker-dealers that operate in the U.S. OTC markets are regulated by the Financial Industry Regulatory Authority (FINRA).

One of the main disadvantages of OTC markets is that securities being traded may lack buyers and sellers, resulting in a lack of liquidity – however, this is not the case within the FX market. This can make it difficult to sell a security at a later date. Additionally, the value of a security may vary widely depending on which market markers trade the asset.

An example of an OTC market in the forex market is when two parties, such as a large corporation and a bank, agree to trade a specific amount of currency directly between each other, without the need for a central exchange or broker. The corporation may need to purchase a large amount of a foreign currency for an upcoming business transaction, while the bank is looking to sell that same currency. They negotiate a price and complete the trade directly with each other, without others being aware of the specific price at which the transaction was completed. This type of OTC market trading in the forex market is common due to the high liquidity and 24-hour nature of the market, making it less likely for a lack of buyers or sellers to occur.