In the trading world, very often, we can hear the expression secondary market. In trading reports, this term can be seen too.
Secondary market definition
The secondary market is the equity and debts market, where investors buy and sell securities from other investors after selling its offering on the primary market. The primary market is the market when securities are first issued.
Read an article about the Primary market and IPO.
The investors are eligible to buy and sell the securities they already possess in a secondary market. This is what most people usually referred to as the stock market. However, these Stocks are normally sold when they are issued in the primary market. Therefore, national exchanges such as NASDAQ and NYSE are secondary markets. When the company’s security is issued for the first time, it is done in a primary market. Therefore, after the Initial public offering(IPO), the securities can now be available in the secondary market.
Additionally, there are also other types of secondary markets apart from traded securities. For instance, individual investors, corporations, and investment banks can buy and sell mutual funds on a secondary market. Therefore, any transaction in this market has been removed from the transaction that had initially created the securities. You will realize that the massively interconnected trades drive the securities based on their initial value.
Characteristics of secondary market
The following features characterize the secondary market.
It creates liquidity
The secondary market is known for creating liquidity in its securities. This implies that it allows immediate conversion of securities into cash. Therefore, any investor can easily obtain his cash because of the buyers’ vast presence in the market.
Secondary Market comes After Primary Market.
It is impossible to trade new securities in the secondary markets because such securities are normally sold in the primary market. Therefore, this makes the secondary market to come in after the primary market.
Secondary Market has a particular place.
The secondary market trading platform is on the stock exchange. However, it is not mandatory that the buying and selling will only be down on the stock exchange. This is because two individuals can decide to mutually buy or sell them, which will also be taken as a secondary market transaction. Therefore, as you have seen, most transactions are made via the stock exchange.
Secondary Market encourages New Investment.
The securities and rates of shares fluctuate in the share market. It leads to a Nationwide increase in investment rates because it attracts many investors.
Secondary Market Adjustment of prices
The secondary market reflects the news or any useful information on the stock price, which allows it to adjust its pricing regarding developing the security.
Secondary Market Low transactions cost
In a secondary market, you will enjoy low transaction costs because large volumes of trades occur.
Secondary Market Assist in price discovery
The supply economics and demand in the market assist in price discovery. It is also another good alternative option that opens avenues to saving.
Role of secondary market
Secondary Market regulations
The secondary market is an important source of liquidity and capital for both the investors and companies. That is why the government imposes heavy regulations on it to ensure the investors’ money is safe.
Additionally, a private secondary market deals with private equity funds where the buyers can stay on them because sellers sell their investments, and their commitment is unfunded. Irrespective of the secondary market type, the government controls its operation by bringing in regulations because they are an important revenue source. Besides, it provides a gateway to control and monitor public perceptions of the company. This, in return, helps in making decisions on the aggregation of information and incentive-based management contracts.
Major Instruments and Players in Secondary Market
The secondary market deals with hybrid instruments, variable income, and fixed income. Some examples of this fixed income include preference shares and debt securities such as debentures and bonds. On the other hand, variable income securities might include instruments such as derivatives and equity. The hybrid instruments are the convertible debentures and preference shares.
Therefore, the key players in this market are advisory and brokerage services such as security dealers and commission brokers. Others include retail investors and financial intermediaries such as non -banking financial companies, mutual funds, insurance companies, and banks.
Types of Secondary Markets
We have two types of secondary markets.
Over The Counter (OTC) Markets
This is a decentralized market where members trade among themselves. An example of such a market is forex. However, there is usually higher competition among the participants because they want to get a bigger share of the trade, making security prices vary. The direct dealings among the parties make it susceptible to counterparty risks.
Exchanges – secondary market stock exchange
This includes NASDAQ and NYSE platforms, where there is no direct contact between the seller and the buyer. The good thing with this type of secondary market is that there are no counterparty risks. It also has good security because of the heavy security that it is imposed. However, the commissions and exchange fees make it have higher transaction costs.
Pricing in the Secondary Market
In the secondary market, the price of security is usually determined by the supply of demand, while in the case of the primary market, the security is set beforehand. For instance, the demand for a stock will do if an investor believes that the stock would increase in demand, influencing the pricing. A price drop occurs when the investors feel the stock will lose value.
- The importance of the secondary market is an indicator of the country’s economy.
- It helps the company to control and monitor public perceptions.
- It gives a company value for being an economic force.
- It allows investors to make some returns on idle money.
- It guarantees liquidity for the investors because they can easily sell or buy securities.
The difference Between The Primary and Secondary Markets
In the primary market, the IPO is primarily sold in this market, but the IPO will be traded there in secondary markets.
Prices don’t fluctuate in the primary market, but they fluctuate in the secondary market.
The price of security is set beforehand in the primary markets, whereas the supply and demand are the key basis of price determination for the secondary market.
In the primary market, the sales go to the issuing company, while the sales go to the investors who are selling them for the secondary market.
Purchases through an IPO require a large investment in a primary market, but an investor can buy as many shares that he wants for the secondary market.
Companies hire banks to manage their IPO in the primary market, but in her case, investors hire brokers to manage the trade.