Pricing in the OTC market - A look inside the Exness trading engine
By Reem Bacha
18 December 2023
For over 15 years, Exness has been committed to providing our clients with full transparency when it comes to our pricing and execution. But, to fully understand the inner workings of our pricing algorithms and spreads, it’s going to take a little more than just giving traders access to our full tick history.
With that in mind, here is the first installment in a series of five that will not only show you how Exness generates its pricing but also how most banks and large financial institutions do it.
The first step is to break down one of the most fundamental and misunderstood terms in the business – the over-the-counter market.
What is the OTC market?
The OTC market plays a crucial role in the financial space. It offers flexible transaction structures and gives participants access to a wide range of assets. It typically involves lower trading costs and regulatory requirements compared to traditional exchanges.
How does the OTC market differ from exchanges?
The Over-The-Counter (OTC) market is made up of independent, decentralized participants where two parties trade financial instruments at a price they agree on, without a centralized exchange in the middle.
Many market participants are involved in OTC trading, including hedge funds, investment banks, market makers like Exness, and more. In simple terms, any transaction completed without a centralized entity in the middle is an OTC transaction. If, for example, you buy a used car from your neighbor, that is considered an OTC transaction, as there is no central marketplace for used cars that provides an official price. It’s up to you and the seller to decide at which price to transact.
The OTC market and pricing
In the OTC market, the same assets are traded across a multitude of marketplaces. This means that prices naturally vary from one marketplace to another, as different transactions within each marketplace move the price. That said, arbitrage ensures that these differences don’t exist for too long. For the same reason, spreads also differ depending on both the amounts of liquidity available and the desire of the price provider to transact.
Let’s take another example
When you visit different banks to exchange currency, you might find that each bank offers a slightly different exchange rate; this variation is similar to the OTC market, as banks set their rates based on their own costs, demand, supply, and risk assessments. This can lead to slightly differing prices and spreads for the same currency at each bank. Some banks might set a daily rate with a widespread, while others might update their rate in real-time and offer tighter spreads.
To simplify it even further, let’s go back to the example of the car. You bought a car from your neighbor because you knew that the price for the same type of car is usually higher. Then you decide to sell it for more money, and you post an ad in the biggest car marketplace. Because of arbitrage opportunities that exist between different marketplaces, you can make a profit.
A deeper look at arbitrage
Market dynamics are ever-changing, and you have to be very fast to capitalize on these price inefficiencies - especially when it comes to online trading where you are competing with other algorithms programmed to exploit such opportunities. You’ll find them everywhere – not just in the FX market, but across other markets too.
Spot metals, energies, indices and cryptocurrencies are no exception to this phenomenon, and different prices might appear for the same asset at the same time, in different places.
Participants can make money by buying where an asset is cheap and selling where its price is high, capitalizing on price differences that may exist across different marketplaces, trading platforms, or geographical locations to earn profits from these discrepancies.
Now that we’ve broken down what the OTC market is, and explored the intricacies of pricing variations and arbitrage, it’s time to take a closer look at how prices are actually generated. The next article in this series will explore the logic that governs pricing generation, not just at Exness, but across the industry in general.
This is not investment advice. Past performance is not an indication of future results. Your capital is at risk, please trade responsibly.
Reem Bacha is a dedicated content professional and product communications specialist with over 8 years of experience in the FinTech sector.