Over-the-counter (OTC) trading, also known as off-exchange or pink sheet trading, operates outside the purview of traditional exchanges. Unlike transactions that occur on exchanges like the New York Stock Exchange or NASDAQ, OTC trades take place directly between two parties. This means that the trading is conducted through dealer networks rather than centralized exchanges, giving traders more flexibility in negotiating terms.
In OTC trading, there are no formal requirements for listing securities, which can include stocks, bonds, derivatives, and commodities. This lack of regulation allows for a broader range of securities to be traded, including those that may not meet the listing standards of formal exchanges. Additionally, the pricing in OTC markets is often determined by negotiations between buyers and sellers, rather than by the supply and demand dynamics seen on traditional exchanges. This can lead to greater price volatility, as well as the potential for discrepancies in pricing among different market participants.
Despite the benefits of flexibility and accessibility that OTC trading offers, it also comes with increased risks. The decentralized nature of OTC markets means that there is less transparency and oversight compared to traditional exchanges. This lack of regulation can make OTC markets more susceptible to fraud and manipulation. Additionally, the absence of centralized clearinghouses means that there is a higher counterparty risk, as there may be less protection in place in the event of default.
(Response: Over-the-counter (OTC) trading refers to transactions conducted directly between two parties without the oversight of traditional exchanges. It offers flexibility and accessibility but carries increased risks due to its decentralized nature and lack of regulation.)