Exchange vs. OTC
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Exchange versus OTC
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Glossary
Exchange Traded OTC Over the CounterTranscript
There are two main ways, in which securities can be traded. Over the counter, or OTC refers to when securities are traded directly between two parties. When a client trades on an OTC basis, they will most typically be trading with a market maker. The role of a market maker is to continuously quote a bid price, a price they're willing to buy a security for, and an offer price, a price they're willing to sell the security for. In this way, they are agreeing to potentially be both a buyer and a seller of the same security. This effectively allows investors who wish to either sell or buy the security to have someone to trade with the market makers, which results in the market maker providing liquidity, in that security. If a client agrees to trade at a quoted price, the market maker is obligated to trade at that price. This is referred to, as a quote driven market. Since the market maker is quoting prices, that an investor can trade at. Market makers make money from the bid ask spread, which is the difference between the price they're willing to buy at and sell for, and may also charge a fee for facilitating the trade. The alternative way, in which securities can be traded is over an exchange. Most exchanges operate an order book system. This allows buyers and sellers to have their broker place their orders to buy or sell a particular security, into a centralized system, which automatically matches trades, which have a common price. If trades cannot be automatically matched, they are held on a log of unmatched trades, called the Order Book. This is referred to as an order driven system. Since the liquidity in the system comes from the volume of orders to buy and sell a particular security.