Off-Exchange Trading Depth Analysis: OTC Market Operation Mechanisms and Risks Investors Must Know

Why Do You Need the OTC Market?

Investors often face a dilemma: they discover a promising emerging company but cannot find it on mainstream exchanges. At this point, they need to turn to the OTC market. OTC (Over The Counter) refers to a decentralized trading market where investors buy and sell various financial products through banks, brokers, electronic systems, and other channels outside of centralized exchanges.

Rather than being a physical location, OTC is more like a trading system. This market is also known as ‘Over-the-Counter Trading,’ ‘OTC Trading,’ or ‘Over-the-Counter Market,’ where prices are negotiated directly between trading parties rather than determined by a unified market auction.

Why do companies choose to list on the OTC market instead of formal exchanges? The main reasons include:

• Small and medium-sized enterprises and startups that do not meet listing qualifications
• Companies with sufficient scale but opting for commercial considerations (to avoid excessive information disclosure)
• Growing companies preparing to apply for listing

How the OTC Market Operates

Taiwan’s OTC market operates similarly to the listed market, with the entire process as follows:

Stage 1: Placing Orders and Uploads
Investors place orders through brokers, identical to purchasing listed stocks. Brokers then upload the orders to the OTC Center’s automated matching system.

Stage 2: Matching and Execution
The Automated Trading System (ATS) matches orders based on the principles of “price priority, time priority,” with technical rules synchronized with the listed market.

Trading Hours and Rules:

Core Trading Rules:

• Price fluctuation limit: ±10% (same as the listed market)
• Matching frequency: every 5 seconds during call auctions
• Settlement system: T+2 (settlement completed two working days after the transaction)

These consistent rules mean that for ordinary investors, participating in OTC stocks is not difficult—just go through a legitimate broker.

Types of Products Traded in the OTC Market

The OTC market offers a much wider variety of products than centralized exchanges, mainly including:

Stocks
The biggest feature of OTC stocks is that they include unlisted small and medium-sized enterprise stocks. These companies may be smaller, newer, but have growth potential. Meanwhile, the OTC Index (also called the OTC Market Index) reflects the overall trend of these small and medium stocks, allowing investors to gauge market movements.

Bonds
Bonds are more suitable for OTC trading because they are issued in large quantities, diverse in types, but traded less frequently, making standardized centralized trading less appropriate.

Derivatives
Options, futures, spread contracts, and other derivative products are common in OTC markets.

Foreign Exchange and Cryptocurrencies
Various currency trades and mainstream cryptocurrencies are conducted in OTC markets. Especially for cryptocurrencies, OTC allows large token purchases in one go, which is difficult to achieve on dedicated crypto exchanges.

Core Differences Between OTC Markets and Centralized Exchanges

The fundamental difference lies in their operating logic: centralized exchanges follow standard specifications and unified rules, while OTC markets are closer to free-market supply and demand.

① Product Characteristics

• Centralized Market: Standardized (e.g., banks’ gold trading with uniform standards)
• OTC Market: Non-standardized (e.g., pawnshops with different conditions)

This means OTC can trade a broader range of products, but both parties need to have in-depth product knowledge.

② Trading Mechanism

• Centralized Market: Transparent call auction, relatively fair but profit margins are limited
• OTC Market: Negotiated bilateral trading, where information is more important than capital

In OTC, the same product may be sold at different prices to different buyers. Investors with sufficient information can obtain better deals.

③ Regulation and Transparency

• Centralized Market: Government-approved, strictly regulated, trading data publicly available
• OTC Market: Less regulated, trading details may not be disclosed

Lack of mandatory disclosure can lead to information asymmetry, allowing familiar traders to earn excess profits while less informed traders may suffer losses.

④ Liquidity

• Centralized Market: High trading volume and liquidity
• OTC Market: Lower trading volume and relatively less liquidity

Due to better regulation and international capital attraction, centralized markets tend to be more active.

⑤ Trading Flexibility

• Centralized Market: Strict risk controls, more restrictions on leverage and short selling
• OTC Market: Fewer restrictions, more flexible leverage and trading methods

Opportunities and Risks in the OTC Market

Advantages:

✔ Wide Investment Options - Access to unlisted companies, derivatives, binary options, and more diversified investment forms

✔ Flexible Customization - Adjust trading product specifications and methods according to personal investment goals

✔ High Leverage - Compared to the low leverage limits of centralized markets, OTC offers higher leverage options to amplify returns

✔ Market Optimization - Modern OTC markets have incorporated multiple safety mechanisms, gradually approaching the safety level of centralized markets

Risks to Watch Out For:

❌ Insufficient Regulation - Lack of unified rules and full transparency, with lax oversight leading to fraudulent brokers

❌ Liquidity Risk - Low liquidity of securities, making it difficult to execute trades at desired prices

❌ Counterparty Risk - Both parties bear the credit risk of the counterparty

❌ Information Asymmetry - Investors cannot access the same level of public and transparent information as in centralized markets

❌ Market Volatility - Susceptible to market swings, some products exhibit large fluctuations and poor liquidity

Safety Considerations for OTC Over-the-Counter Trading

Is OTC market inherently unsafe? The answer is not absolute. Compared to centralized exchanges, OTC does carry higher risks, but they are not uncontrollable.

To ensure safe OTC trading, investors should pay attention to:

First: Choose reputable brokers

• Brokers should be licensed and regulated by multiple authorities
• Possess strong risk management capabilities
• Ideally offer investor protection measures (risk assessments, KYC verification, complaint mechanisms, etc.)

Second: Select trading products carefully

• Prefer mature, liquid products (e.g., forex)
• Understand trading features such as spreads and liquidity in depth
• Consider ease and safety of withdrawal

Third: Master market knowledge

• Be aware of the risks of negotiated pricing between trading parties
• Beware of false information and scams
• Establish a comprehensive risk management system

Taiwan’s Unique Position in the OTC Market

Taiwan divides its stock market into two tiers: the “Stock Exchange” and the “OTC Center,” aiming to balance enterprise development and market regulation.

Overly strict listing requirements can hinder many startups. Therefore, the government established the OTC Center, relaxing listing thresholds—companies only need to be recommended by more than two licensed brokers to list. If a company shows performance improvements (profitability or operational health) within six months, it can apply to transfer to the main or OTC market.

This mechanism provides growth companies with financing channels but also presents challenges: lowered thresholds attract some lower-quality firms, and even malicious actors may set up fake brokers for scams. Therefore, investors should not only choose the right targets but also partner with reputable brokers.

Conclusion

The OTC market represents a direction for diversified development in the financial markets. As internet development and international finance expand, more investors demand greater convenience and accessibility in trading. The OTC market is gradually meeting these needs. Meanwhile, the OTC market has rapidly grown into a significant segment, becoming a preferred choice for many investors.

Compared to the standardized and strictly regulated centralized exchanges, OTC offers more flexible trading methods and a broader range of investment products. However, the higher freedom also demands greater knowledge and risk tolerance from investors. By employing proper trading strategies, choosing secure platforms, and fully understanding market rules, investors can seize more opportunities in OTC, but must remain vigilant against hidden risks.