Secondary Market

The secondary market is the market in which investors trade securities that have already been issued. When one investor sells a share or a bond to another, the money passes between the two investors; the company or government that originally issued the security receives nothing. Almost all daily activity on a stock exchange, and most trading in bonds and currencies, takes place in the secondary market.

It is the counterpart of the primary market, where securities are sold for the first time and the issuer collects the proceeds. The term is used for shares, government and corporate bonds, loans, mortgages that are pooled through securitization, and even stakes in private equity funds, which change hands in a growing "secondaries" market.

Concert tickets are a familiar comparison. The first sale happens at the box office, and the money goes to the band. If you later cannot go, you sell your ticket to a friend or on a resale site; the band gets nothing, but the ticket still has a price, and that price tells everyone how much demand there is for the show.

The secondary market does the same for investments. It lets people get their money back before a bond matures or without waiting for a company to pay them out, and the prices set by all that buying and selling tell companies and governments how much new investors would pay next time.

• Exchanges. Shares, exchange-traded funds and listed derivatives trade on regulated exchanges, where orders meet in a central order book and prices are public.
• Alternative venues. In the United States and Europe, much share trading takes place on alternative trading systems, multilateral trading facilities and dark pools, which hide orders until they are executed.
• Over the counter. Most bonds, currencies and many derivatives trade through over-the-counter trading, where a dealer quotes a price to a client directly rather than through an exchange.
• Dealer markets for government debt. Primary dealers buy government bonds at auction and then make markets in them for investors.

Rules on how these venues compete differ. The US Regulation NMS of 2005 requires trades to be routed to the best displayed price across venues, while the EU's MiFID II rules, applied from January 2018, set transparency and best-execution requirements across European markets.

The value of a secondary market lies in liquidity, the ability to trade quickly, in size and without moving the price much. Liquidity is supplied by a market maker or dealer that stands ready to buy at a bid price and sell at a slightly higher ask price. The difference, the spread, is its reward. As a percentage of the midpoint price it is:

For a share quoted at a bid of $99.90 and an ask of $100.10, the spread is $0.20 on a midpoint of $100, or 0.2 percent. Large shares on major exchanges often trade with spreads of a few hundredths of a percent; small company shares, frontier-market bonds and an illiquid asset such as a private company stake can have spreads of several percent. High-frequency trading firms now provide much of the quoting in equities, which has narrowed spreads but raised questions about how reliable that liquidity is under stress.

A secondary market does not raise new money directly, yet it underpins the whole capital market:

• It makes primary issues possible. Investors accept long-dated or permanent securities because they can sell them later, so issuers pay a lower cost of capital.
• It sets prices. Continuous trading performs price discovery, and secondary prices for a company's existing shares or bonds set the terms of its next issue.
• It transmits policy. Central banks buy and sell government bonds in the secondary market through open market operations and asset purchase programmes, influencing yields across the economy.
• It allows risk to be transferred. Investors can adjust holdings, hedge and take long and short positions, including through short selling.

Secondary markets can fail when they are most needed. In the 2008 financial crisis, trading in many mortgage-backed securities dried up, and in March 2020 even the US Treasury market, normally the most liquid in the world, suffered severe strains until the Federal Reserve intervened. Such episodes are studied as sources of systemic risk.

Critics also argue that heavy secondary trading is largely a transfer between investors that adds little to the real economy, and that rapid trading encourages speculation and short-termism; some support a financial transaction tax such as a Tobin tax for this reason. Defenders reply that liquid secondary markets lower the cost of capital for everyone and that frequent trading improves price accuracy, as described by the efficient market hypothesis.

• Investor.gov: How stock markets work
• European Securities and Markets Authority (ESMA)