Is OTC (Over-the-Counter) trading really unsafe? A complete interpretation from definition to risks

What is OTC and Why Does It Exist?

When it comes to investing, many people first think of regulated exchanges like Shanghai, Shenzhen, or Beijing A-shares. But in the financial world, there is another massive trading market that has been unnoticed for years but is enormous in scale — the OTC market, also known as Over The Counter.

The core logic of OTC (Over The Counter) is simple: buyers and sellers skip centralized exchanges and negotiate directly to complete transactions. This trading method has a long history; early on, it was conducted through bank counters, phone calls, and faxes. In the internet era, it has evolved into electronic systems. When companies cannot list on mainstream exchanges (perhaps due to small size, being in early startup stages, or not meeting listing requirements), investors can still trade through the OTC market.

Unlike the centralized bidding process of formal exchanges, OTC markets operate on a negotiation-based system: traders act as market makers, quoting prices that may differ for different buyers, and both parties negotiate based on supply and demand to reach an agreement. This flexibility has driven explosive growth in OTC markets over the past few decades, especially in financial derivatives and crypto assets.

What Can Be Traded in the OTC Market?

OTC trading covers a much broader range of products than exchanges:

Stocks and Bonds — Unlisted company stocks and small to medium enterprise equities are most liquid in OTC markets. Bonds, due to large issuance volumes, diverse types, but low trading frequency, are primarily traded OTC.

Derivatives Ecosystem — Options, futures, Contracts for Difference (CFDs), and other advanced financial instruments mainly circulate in OTC markets. This is the main channel for traditional investors to upgrade into derivatives trading.

Foreign Exchange Market — Global currency trading is primarily OTC; forex transactions completed via various platforms fall into this category.

Cryptocurrencies — Digital assets facilitate large-volume transactions in OTC markets. When purchasing large amounts of Bitcoin, Ethereum, and other cryptocurrencies, OTC providers often offer better execution prices and liquidity.

American Depositary Receipts (ADRs) — Overseas companies, to bypass listing requirements on major US exchanges, often initially issue bank certificates representing their stocks in OTC markets.

OTC VS Exchanges: A Three-Dimensional Comparison

Is OTC Really Unsafe? The Complex Truth About Safety

Does the lack of strict exchange regulation mean OTC off-exchange trading is inherently risky? There’s no absolute answer.

Existing Risks:

The OTC market’s lack of unified rules and transparency mechanisms makes it a breeding ground for fraudulent brokers. Without centralized market disclosures, investors often have less access to information compared to exchanges. Liquidity risk is also significant — OTC securities often have fixed counterparties, so if you need to sell quickly, you might not find a suitable buyer or may have to accept a lower price.

Leverage risk is another hidden danger. OTC markets offer high flexibility in leverage ratios, but many retail investors lack risk awareness, blindly increasing leverage and risking margin calls. Coupled with market volatility, OTC investors cannot access real-time, transparent market information like exchange traders.

Controllable Aspects:

OTC trading’s safety is not entirely hopeless. The key is to choose regulated brokers. Although overall OTC regulation is lax, professional brokers often undergo multiple layers of oversight (such as by financial conduct authorities) and have robust risk control systems. Selecting such institutions and understanding details like spreads, liquidity, withdrawal processes can significantly reduce risks.

Why Do Investors Still Choose OTC?

Despite the risks, participation in OTC markets is rising, driven by:

✔️ Broader Investment Options — OTC breaks the restrictions of exchanges, allowing access to startup equities, derivatives, forex, cryptocurrencies, and more, catering to different risk appetites.

✔️ Flexible Trading Modes — Product specifications, trading hours, and volumes can be customized according to needs, unconstrained by standardized exchange rules.

✔️ Leverage Efficiency — Compared to traditional markets with strict leverage caps, OTC offers greater leverage, attracting aggressive investors.

✔️ Progress in Security Measures — In recent years, OTC markets have evolved in multi-layer regulation, transparency, and risk management tools, gradually narrowing the gap with exchanges.

Core Risks of OTC Trading

Understanding these risks is essential before engaging in OTC investments:

Regulatory Vacuum — OTC lacks a unified legal framework; some non-compliant companies and securities can only circulate here, making it easier for fraudulent brokers to hide.

Liquidity Dilemmas — Inability to find buyers can trap your position, and transaction prices may be far below fair market value, especially during market volatility.

Information Asymmetry — Limited access to market information weakens decision-making, leaving investors relatively passive.

Leverage Traps — High leverage amplifies gains but also risks, and a single misjudgment can wipe out your entire capital.

Market Risk — OTC securities tend to be more volatile than exchange-traded securities, lacking the support of stable institutional investor liquidity.

How to Safely Conduct OTC Trading? Practical Tips

1. Choose Reputable Brokers — Prioritize institutions regulated by internationally recognized financial authorities; verify licenses and track records.

2. Ensure Cost Transparency — Fully understand spreads, fees, financing rates, and hidden costs to avoid hidden deductions.

3. Use Risk Control Tools — Learn to apply stop-loss, limit orders, and set risk thresholds to prevent losses from escalating.

4. Use Leverage Rationally — Start conservatively with lower leverage, gaining experience and risk management skills before gradually increasing.

5. Actively Gather Information — Don’t rely on a single source; obtain market insights from multiple channels to compensate for transparency gaps.

Summary

OTC off-exchange trading is neither a forbidden zone nor a guaranteed shortcut to profit. It is a highly flexible, high-risk, high-reward trading ecosystem suitable for investors with risk awareness and capital management skills. When choosing legitimate brokers and mastering risk control, OTC trading can be a valuable supplement to your investment portfolio. But remember, all investment activities require rationality and caution, especially OTC trading.