Secondary market

Key Takeaways

  • The secondary market refers to space where securities are traded after changing hands from the original issuer.
  • OTC and Exchanges are the two main types of secondary markets.

What is the Secondary Market?

The secondary market refers to space where securities are traded after changing hands from the original issuer. Often it is an exchange, and the securities could be either equity shares, ETFs, or close-ended funds.

For ETFs, this refers to the exchange on which ETF units are traded by retail investors. It is called a secondary market because the ETF units are twice removed from their creator, as authorized participants further break up their block units and then release them for trading in the secondary market.

What is the difference between the primary market and the secondary market?

When a company or central bank issues a financial instrument for the first time, and it is sold to the investors directly, this transaction is said to have happened in a primary market. Some of the common primary market transactions include initial public offerings or IPO. In an IPO, the transaction occurs between the investor and the investment bank, who is underwriting the IPO. 

When these initial investors decide to let go of or sell their stake in the business, they can do that through the secondary market. The proceeds of such secondary transactions do not go to the issuing company.

What are the types of Secondary markets?

Secondary markets are primarily of two types which are mentioned below:

  • Over-The-Counter or OTC Market

These markets are a decentralized space where investors trade amongst themselves. In such markets, there is a very fierce competition to get higher volumes, which leads to a difference in prices from one seller to another. Compared with exchanges, the risk is higher as the seller and buyer deal on a one-to-one basis. The foreign exchange market is an example of OTC markets.

  • Exchanges

In this type of secondary market, one will not find direct contact between the seller and the buyer of the security. To make trading safe and secure, heavy regulations are in place. Counterparty risk, in this case, is almost zero as the exchange is a guarantor. In Exchanges, there is a comparatively high transaction cost because of the exchange fees and commission.

Secondary markets can also be divided as:

  • Auction Market

This type of secondary market offers a platform to the sellers and buyers to meet and announce the price at which they both want to transact their securities.

  • Dealer Market

In this type of market, electronic platforms such as fax machines or telephones facilitate the transactions.

Advantages of Secondary Markets

The benefits of secondary market trading are:

  • It offers investors to make good gains in a shorter period.
  • The stock price in these markets helps in evaluating a company effectively.
  • For an investor, the ease of selling and buying in these markets ensures liquidity.
  • Trading in secondary markets does not require a hefty amount, thus facilitating investments of small ticket investors.
  • Secondary markets help in analyzing the economic health of a company. 

Disadvantages of Secondary Markets

The drawbacks of trading through secondary markets are:

  • Price fluctuations are very high in secondary markets, which can lead to a sudden loss.
  • Trading through secondary markets can be very time consuming as investors are required to complete some formalities.
  • Sometimes, government policies can also act as a hindrance in secondary markets.
  • Brokerage fees are high as every time an investor sells or buys shares, he/she needs to pay a brokerage commission.

Functions of Secondary Markets | Features of Secondary Markets:

Following are the secondary market characteristics:

  • Secondary markets provide liquidity to investors
  • Secondary markets enable the investors to check the price of various financial instruments, including shares and bonds along with their interest rates
  • The secondary market acts like an intermediary as it helps determine the price of securities during a transaction
  • Secondary market assists in mobilizing and channelizing the savings of investors

What is the difference between Primary and Secondary Market? | Primary Market vs Secondary Market

Primary Market Secondary Market
When new stocks and bonds are publicly sold for the first time by the company, it is through the primary market. A secondary market is a place where the securities issued in the primary markets are traded.  
Primary Market is also referred to as new issues market. Secondary market is sometimes also referred to as stock market.
Investment Banks are considered to be the intermediaries between the company and investors willing to buy shares in the primary market The broker is an intermediary in a secondary market