OTC vs. exchange trading: the differences might surprise you

BONDY ON MONEY

July 16, 1995|By SUSAN BONDY | SUSAN BONDY,Creators Syndicate

Q: Is there a difference between buying a stock that is listed on an exchange and buying an over-the-counter stock?

A: Here are the three major differences:

* Stock prices are arrived at through different processes.

* The major exchanges have more stringent requirements for listing a stock.

* The prices may be quoted differently in the newspaper and by the broker.

A stock exchange centralizes trading in one location -- the floor of the exchange. There, buyers and sellers come together and, following auction principles, agree on a price for the trade. The shares change hands, or are "crossed," and the actual trade appears on the ticker tape for everyone to see.

Each stock is assigned to one specialist who is supposed to maintain an "orderly market." If the volume of buyers matches the volume of sellers, the shares are simply crossed. If there is more stock for sale than buyers, the specialist can step up and, using the firm's capital, buy the excess stock for inventory. The ,, specialist will mark up the price of the stock and sell it at a profit. This profit is compensation for the risk that if the price moves down, the stock may be sold at a loss.

Over-the-counter (OTC) trading means there is no auction market for the stock. Instead, individual firms declare themselves "market-makers" in that stock. These brokerage firms buy the stock from shareholders, mark it up and sell it.

The price a market-maker is willing to pay for your shares is the "bid" price. The price you pay to buy the stock from the market-maker is the "asked" price.

When there are multiple market-makers for an OTC stock, each can have his or her own bid and asked prices, and they are not necessarily the same. The quotes shown on the broker's screen are the highest bid price and the lowest asked price.

The bid and asked prices for OTC stocks are not real trades. They are merely a range of possibilities. As a result, actual trade and volume levels for the day cannot be monitored. The volume numbers on a broker's quote machine reflect the previous day's trading.

The exception to the rule is the National Market System, an automated trading system for major OTC stocks. This system does show "live" trades with real prices and numbers of shares. At present, it includes more than 3,500 stocks.

In both exchange and OTC trading, orders are placed through a trader who is a registered representative (also called a broker). This person acts as the intermediary between you and the

exchange floor or the independent market-maker.

In general, stocks traded on the major exchanges tend to be those of larger and more stable companies. However, a growing number of large companies, whose earnings and assets qualify them for the major exchanges, choose to stay with the National Market System. They prefer multiple market-makers to being at the mercy of one specialist.

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