Over-the-Counter Trading or OTC Trading in Unlisted Stock Market
Here is a quick read up on the Over-the-counter Trading or OTC Trading. Unlisted Stock Market is a hub for a lot of investors and this article briefs on the same.
When it comes to unlisted stocks, you trade them over-the-counter (OTC), right? However, have you ever thought about what exactly this over-the-counter means?
Is there any physical counter to deal with these shares? Why investors can trade unlisted shares only over-the-counter?
And there are lots of other questions regarding OTC that must be hovering in your mind right now after reading this.
So, let us answer each of those questions and learn about over-the-counter trading and how it is related to unlisted shares, in this article.
What is OTC Trading?
OTC stands for over-the-counter trading. It is a form of trading where the brokers and the dealers offer stocks to the investors directly.
Unlike in a centralized exchange, where everything is dependent on the brokers or the dealers. It is a network of brokers and they operate the whole process of trading.
In simple words, over-the-counter means, you are buying or selling the shares to the brokers directly without any stock exchange in between.
Sometimes, securities cannot meet the eligibility criteria of the stock exchanges. Then the buyers and the sellers of these securities trade them over-the-counter.
This trading process is not regulated by any stock exchange or SEBI in India.
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Types of OTC Securities
There are four different types of securities that one can trade over the counter. The OTC securities include
- Debt securities
Generally, these securities are of those companies which have limited capital, limited resources, and are small-scale companies. These companies couldn’t get listed on the stock exchange.
However, if the companies have growth potentially then some traders and investors invest in these securities on the OTC platform.
The investors mainly trade derivatives over the counter. It is because of the fact that the derivative contracts can be made as per the specifications of the two parties.
This is not possible on the stock exchange, where the specification of the derivatives contracts is pre-decided.
This helps the investors hedge their risks pretty well. At times it is even referred to as ‘perfect hedge’.
How does OTC Trading work?
The process of trading over the counter involves OTC Networks and investors and traders.
OTC network means the network of brokers and dealers. These brokers and dealers can deal specifically in OTC securities like unlisted shares or both listed and unlisted ones.
If you want to buy stocks or other securities over the counter, then you need to first contact brokers/dealers of the OTC network.
The investors or the traders thus need to pay certain fees as brokerage to these dealers or the brokers. The fees vary from one broker to another.
The time taken in executing the trades on OTC is longer than it is in the stock exchanges.
It is because, though the broker and the investor directly contact and trade, research negotiation takes a lot of time which is not there on the stock exchange.
Benefits of OTC Trading
There are certain benefits of trading over the counter –
- You can trade or invest in shares that are not there on the stock exchanges. You can invest in unlisted shares, derivatives, commodities, and others.
- There are no stringent regulations of the exchanges or the SEBI. You can freely trade unlisted stocks over the counter.
- You do not need to pay any STT as the transaction is only happening outside a stock exchange.
- The charges of the brokers are comparatively lower than the ones who deal in listed stocks or operates on stock exchanges.
Risks involved in Over-the-Counter Trading
While there are some major benefits of trading over the counter, there are certain risks as well.
- Since there are no regulations, price manipulation is prevalent in the OTC market.
- The securities on the OTC platform are very illiquid. It is because there are not many buyers and sellers for these securities.
- The trade’s execution time is longer than it is on the stock exchange.
- Financial reports, company data are difficult to get for the OTC securities.
- There are very few dealers and brokers who deal in the OTC market.
OTC Trading – Conclusion
OTC market has both pros and cons to it. While you can trade stocks of unlisted companies on OTC, on the other hand, due to no regulations, it is riskier.
Similarly, even though you are dealing directly with the broker, but the time taken to execute the trades is more.
However, for unlisted shares, you need to trade or invest via the OTC market only. If you do your research thoroughly then it becomes easy to deal with the OTC market.
FAQs – Over-the-counter Trading
Here are few FAQs related to OTC Trading –
What is the OTC market?
OTC market is a stock market where stocks that are yet to be listed are being traded. It is not an official exchange to trade stocks neither it has any physical existence. It is a network of dealers/brokers and investors or traders.
Who are the dealers or the brokers in the OTC market?
Dealers or brokers are the individuals or the firms that deal in OTC securities. They buy from the companies and then offer those securities to the investors in the OTC market. Similarly, they also buy from the investors when the investor sells those securities.
Is it safe to trade or invest in the OTC market?
If you are thoroughly researching about the company, its operations, financial standing, and then wisely choose the security to invest via OTC, then you are safe.
What is a centralized exchange?
Centralized exchange is a stock exchange that is nationally recognized like National Stock Exchange or Bombay Stock Exchange.
These stock exchange deals in stocks and other securities which are listed on them. It is the opposite of the over-the-counter market where investors and dealers deal in listed securities.
What is STT?
STT stands for Securities transaction tax. You need to pay this when you are trading or investing in stocks or other securities on any centralized stock exchange. For instance, if you are trading on BSE or NSE.
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