Over-the-counter (OTC) trading refers to a decentralized market where trading of financial instruments takes place directly between two parties, without the supervision of an exchange. This kind of trading is often used for securities that aren’t listed on formal exchanges, commodities, and derivatives.
A few key advantages of OTC trading vs traditional Exchanges are Flexibility, Privacy, Accessibility to financial instruments that may not otherwise be available on other exchanges.
Lack of Regulation and Counterparty Risk: Oversight in OTC markets can expose businesses to counterparty risks. To mitigate this, it’s crucial to conduct thorough due diligence before engaging in any transaction.
Fair Pricing, a lack of transparency: OTC markets can lack transparency, making it difficult to determine fair pricing. Using trusted pricing sources or brokers can help ensure you’re getting a fair deal.
Diversify Invesment to mitigate liquidity risk: Some OTC instruments can be illiquid, making them difficult to sell quickly. By diversifying investments, businesses can manage this risk to not overly rely on OTC securities.
Centralised clearing house required Operational Risk: Without a centralized clearing house, operational risks such as errors in trade execution can occur. Implementing robust operational processes and controls can help manage these risks.