"OTC" stands for Over-the-Counter, which is a trading method conducted outside the formal securities exchange. In the OTC market, trading parties directly engage in transactions through phone calls, electronic trading platforms, or other means, rather than through a public exchange.
This means that the OTC market is more decentralized compared to traditional securities exchanges.
The OTC market is typically suitable for smaller or less liquid securities that do not qualify for listing on mainstream exchanges. It also includes companies that do not meet the listing requirements of exchanges or foreign companies trading in the United States.
For example:
Let's assume there is a startup company called X Tech, which, due to its unstable business, does not meet the conditions for listing on a mainstream securities exchange. However, because of its innovative products and technology in the tech industry, it has attracted the interest of some investors.
In this case, X Tech may choose to trade on the "OTC market" to provide liquidity for its stock and attract more investors. The management team of X Tech believes that through the OTC market, they can raise more funds for research and business expansion.
Suppose X Tech issues 100,000 shares of stock on the OTC market and sets the price per share at $10. A certain investor, Mr. Li, decides to purchase 5,000 shares of X Tech, investing a total of $50,000.
However, due to the lower liquidity in the OTC market, Mr. Li finds that when he wants to sell the stock at a certain point, the trading interest from buyers and sellers is not strong, resulting in him not being able to sell as quickly as he expected at the desired price. In the end, he can only sell the stock at $8 per share, leading to a loss of $2,000 (investment of $50,000 - proceeds of $40,000).
Because of the lower liquidity in the OTC market, it may be challenging to execute trades at the expected prices, leading to significant price fluctuations. Therefore, extra caution and a thorough understanding of the market's characteristics are required when conducting OTC trades.
Investors should also conduct risk assessments based on their investment goals and risk tolerance to make informed decisions.
It is important to note that the OTC market has some characteristics and risks compared to mainstream exchanges:
Lower liquidity: OTC market securities are typically from smaller companies or less-traded securities, resulting in lower liquidity. Investors in the OTC market may face wider bid-ask spreads and lower trading volumes when buying or selling stocks.
Lack of transparency: Due to the relatively decentralized and non-standardized nature of the OTC market, some companies may have less comprehensive information disclosure compared to publicly listed companies. Investors may find it challenging to access accurate information for making investment decisions.
Higher risk: Some securities in the OTC market may carry higher risk. Investors need to be more cautious when conducting OTC trades and conduct thorough risk assessments.
Overall, the OTC market is a relatively specialized trading market, and investors need to fully understand and recognize the associated risks while choosing appropriate trading strategies that suit their investment needs.