Investing in the OTC market

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Investing in the OTC market

Post  Max on Sun Nov 07, 2010 10:24 pm

A couple of things to mention when trading OTC (over the counter).

1. The rules governing the OTC are not as strict as the TSX or NYSE. There is a lot of trust involved in hoping your order is managed correctly. Since I don't trust the guys managing my orders on the TSE, I especially don't the guys in the OTC market.

2. Volume/spread. Stock price moves based on buyers and sellers bidding the price up or down. However, these forces are not allowed to run unchecked. As a control, there is what is called a market maker system which controls the bid/ask price (beginning to sound a little like that "architect" guy from the Matrix). This is essentially a firm that will create liquidity by buying excess sell orders and selling excess buy orders filled out of their personal account. These guys are allowed to profit from this activity, the compete against each other to be chosen, and are chosen by listing company when they list their stock. It has a lot of potential for corruption. Now think about the OTC stock that doesn't have as good oversight as the TSX and this same corrupt system in place.

This is one reason there will be a huge difference between the bid and asking prices in OTC. Basically this spread is like a built in commission. If you were to buy and sell the same stock at the same moment in time, you would pay lets say $0.15 to buy and would receive maybe $0.10 when you sell. The average price is somewhere in between and can be bid up and down both by competing investors and by the market maker firm themselves. Also, with a lack of volume, it is likely that it will take a long time for your orders to be filled, and may again require you to sell at a lower price than you expected.

3. Something like 95% of trades never reach the exchange floor, they are "crossed" by brokerages. This is where the same brokerage has a buyer and a seller of the same stock. Now your brokerage is supposed to match the prices against the market to see if they can get a better deal, but who has time, and who can prove they didn't. In the OTC market, the potential for this type of practice is even greater. Also, less reputable brokers can do what is called "front-running", where they trade their own orders ahead of yours (knowing that they will buy before you buy or sell before you sell earning a better price for the broker).

My general advice is to stay away from the OTC market for this reason. However, you are crazy enough to trade in this market at least anticipate these types of activities, and watch the bid/ask spread until you are comfortable with the range enough that you know you are getting a fair price.

Max
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Re: Investing in the OTC market

Post  jon on Fri Nov 26, 2010 5:16 pm

A couple of things to mention when trading OTC (over the counter)

Here's something most people don't know , the term OTC is now called over the counter , but originally , it was meant to be "On The Curb".


From Wikipedia, the free encyclopedia:
On the curb is a financial term that describes the act of trading securities outside the mainstream stock exchange, either because the company operating the exchange has very strict listing requirements (cf: alternative stock exchange) or because investors are so interested to continue trading even after the official business hours that they set up alternative avenues for their trading, sometimes even the curbs outside the main stock exchange, which is the origin of the phrase. sunny
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