Trading

Similar to the U.S. stocks exchanges, security prices respond to the supply and demand in the market. Investors desire to buy and sell securities at certain prices and broker-dealers provide liquidity by trading for their own account, matching orders internally or publishing quotes and executing with external broker-dealers. The number of orders, the volume (e.g. share size), the timing of buy and sell orders, and the availability of information determines how prices develop for a particular security.

A step-by-step explanation is the best way to illustrate the trading process. The example below is tailored for individual investors, although many of the same principles apply to institutional investors.

1. Investor Selects a Broker-Dealer — In order to execute a trade, an investor must have an account at a FINRA-registered broker-dealer.

2. Investor Makes an Investment Decision — Investment decisions should be based on thorough research on the company and security. For securities that trade on the OTCQX, OTCQB and Pink markets, investors can use www.otcmarkets.com to access the information companies have provided, including trade data and company news and financials to help facilitate an investment decision.

3. Investor Defines the Order — Investors define the order they wish the broker-dealer to handle. The two primary order types are Limit Order and Market Order.

   • Limit Orders allow investors to specify the exact price they are willing to accept for a buy or sell order. While Limit Orders are designed to offer more price protection for investors, a Limit Order may not be executed if the price of the security does not reach the price stated in the Limit Order

   • Market Orders direct the broker-dealer to immediately execute either a buy or sell order at the current 'market price' — the best bid or offer.

   Investors must decide whether price (Limit Order) or timing/immediacy (Market Order) is more important to them.

4. Broker-Dealer handling of the Order — Once a broker-dealer receives an order, it often goes through the following steps as part of the trading process:

   • Execute Trade Internally — Broker-dealers will typically first determine if the order can be executed internally. Internal executions occur if they can 'match' (same prices for a buy and sell order) Limit Orders or if they provide liquidity against their own account. If they are trading for their own account, they generally must give investors the best available quoted price or better at that point in time. This rule is known as Best Execution and is among the regulations discussed in Part 3 - Regulation

   • Trade Marketable Order Externally — If the broker-dealer cannot, or chooses not to, execute the trade internally they will attempt to execute the trade with another broker-dealer. OTC Link® ATS provides trading and messaging capabilities, which facilitates the process of ascertaining whether the order is marketable. Marketable orders are orders where the price specified can immediately be executed in the market. Market Orders are, by definition, marketable. Limit Orders are marketable if the limit price is less than or equal to the bid price (for sell orders) or greater than or equal to the ask price (for buy orders) (i.e. execution is at a price better than or equal to the limit price). For example, a customer's Limit Order to buy security ABCD for $30 will only be marketable if the offer/ask price is $30 or less. If the offer price is $30.01 or greater, then the limit order is not marketable and will not be executed. If the order is marketable, the broker-dealer may utilize OTC Link® ATS to negotiate a trade.

   • Create/Edit Quote on OTC Link ATS — If the order is not marketable, the broker-dealer may be required to adjust its existing quote to reflect a new price or size. Broker-dealers are only required to update their quote if the price of the order is equal or superior to their existing quote (See FINRA Rule 6460 and Part 3 - Regulation). In many cases, a broker-dealer quote size represents an aggregation of a number of customer orders. Trade Non-Marketable Order Externally - Once a broker-dealer has a quote posted on OTC Link® ATS, they may receive a trade message via OTC Link® ATS from another broker-dealer; as the market changes, a broker-dealer with a standing quote may also initiate a trade message electronically. At that point the broker-dealer may accept, decline or counter (send a different price or size) the offer to trade. The broker-dealers then negotiate trade price/size, one of the main differences between a trading a security off-exchange and trading a listed security. There is no central system that matches/executes orders for off-exchange traded securities — all trades are agreed upon directly between the broker-dealers. OTC Markets Group's trading platform, OTC Link® ATS, facilitates negotiated trading. Broker-dealers are required to be firm at their quote prices up to the sizes displayed. While broker-dealers may communicate by phone, one of the benefits of OTC Link® ATS is the ability for broker-dealers to trade and message electronically, creating a more efficient trading process.

5. Broker-Dealer Reports, Clears and Settles Trade — Once broker-dealers accept an offer to trade through OTC Link® ATS or through another means of communication, they must report, clear, and settle the trade. Part of this process is the confirmation of the trade with the investor; however, the trade will not be complete until final settlement (the delivery of funds by the buyer and the delivery of securities by the seller). All three functions are the responsibility of the executing broker-dealers.

   • Reporting — Broker-dealers are required to report their trades to FINRA. This information is then disseminated by FINRA to the market. OTC Markets Group offers this 'real-time' trade data within a number of its products, and other trade information is generally disseminated on a 15 minute delayed basis

   • Clearing and Settlement — For equity transactions in OTCQX, OTCQB and Pink, clearing and settling, the matching of trades and the movement of money and securities, may be handled by the broker-dealers themselves or by third-parties. For a more detailed analysis of the trading process, please contact our Trading Services department.

Additional Concepts

Further knowledge on the structure of the market is important to understanding the market for a security. The subjects listed below only touch on high-level concepts of trading techniques, strategies and market structure. To find out more information, please see our Whitepapers.

From a trading perspective, liquidity is the ability of a security to be bought or sold without causing a significant movement in the price of the security. The opposite is true for illiquid securities. Liquidity depends on a number of forces, including supply and demand, price transparency, trading history, market venue, market participants and freely tradable shares (public float).

'The Spread' is a term that applies to all markets and represents the difference between the highest bid price and the lowest ask price. For example, if 'the bid' is $10.00 and 'the ask' is $10.10, then the spread is $.10.

Spreads are often a function of the amount of information available in a security. This information may come in the form of past trading data, news or company financials. If very little information is available in a security, spreads may be very large because the broker-dealer does not want to be caught off guard by a better-informed investor. Conversely, active securities with current disclosure tend to have tighter spreads because broker-dealers believe they have sufficient knowledge of the company and the security to buy and sell with confidence. Investor displayed limit order prices may also impact the spread. Investors are wise to pay attention to the spread of any security, and in particular, to those where the issuing company does not provide current or complete disclosure.

Short selling is a trading strategy where an investor, believing that a security is over-valued, borrows (from a broker-dealer) and sells that security, and then repurchases and returns (to the broker-dealer) the security at a lower price. The difference between the sale price and the purchase price is the investor's profit or loss. Short selling is a valid trading strategy; however, there are two important points that investors must remember:

• Short selling carries with it unlimited risk because the purchase price of a security can rise to any price point. Conversely, long investors (buyers) may only lose the amount invested — if, for example, the security price drops to zero.

• Short sellers are subject to situations where a borrowed security can no longer be borrowed which could cause a short squeeze. If a security is no longer available to borrow short sellers can be forced to buy the security at inflated prices in order to cover their short positions.

• Short squeezes tend to occur more often in illiquid securities.