You may have heard of a company going public for the first time, with others telling you it’s a big deal. When a company goes public, investors worldwide are allowed to invest and hold a share of a company with little to no restrictions. This is the most common way of buying equity in the secondary market. Unfortunately, plenty of retail traders that invest will only dig deep enough to know the secondary market because it’s optional for them to know the nuances of capital markets. Learning all four needs will give you an edge in understanding how securities are traded amongst individuals and corporations.
Primary Market
Before delving into the secondary market, the primary market should be covered first because a company gets established during this phase. A Primary market has many multifunctional components, but it is ultimately the market where securities first get created. Whether a corporation is private or public, it will issue stock and undergo underwriting (a middleman who purchases shares for an IPO or a private placement offering).
Private companies have their own regulations and can only be purchased by accredited investors or venture capital funds. Private companies aim to become public at a point in the future due to losing footing in research and development or a shortage in capital. Public companies have investors take a share in the company; in return, the business has more money to work with, creating enriched opportunities.
When a company is going public and issuing shares as a form of equity to an investor, it must register with the SEC and get an S-1 statement approval. When the S-1 is approved, the company ready to go public can look for institutional investors or venture capital firms to buy up stock from the underwriter.
The Secondary Market
Once the first pair of investors, giant corporations, or professional investors are found, the company can be listed on an exchange like the New York Stock Exchange. Then, friends, family, employees, etc., can invest in the public company. In the secondary market, derivatives like futures and options can be traded, contracts that allow investors to trade with each other, or an exchange, to predict a price of an underlying stock in the future. The contract’s winner pockets the difference, and the loser loses money.
Other instruments traded on the secondary market or an exchange consist of ETFs, bonds, short-term debt, mortgage-backed securities, collateralized investments, dividend payments, and more. Although each investment class has its own vital rules and unique characteristics, investors will pick the option they see fit in the current market economy.
The Third Market
The over-the-counter market, also known as the third market, is a marketplace that houses securities or debt that do not trade on a regular exchange. Instead of trading on an exchange, all trades are decentralized and exchanged on a peer-to-peer base. Penny stocks are traded on the third market because they didn’t meet the requirements to be traded on a large exchange. Other investments, like most bonds, are traded on the third market between large broker-dealers and lenders like investment banks or pension funds. The third market is often overlooked, but it’s typically the marketplace where some of the most significant trades occur.
Other investment options that trade on the third market are the foreign exchange market and foreign stocks listed outside of the United States. An essential characteristic of the third market is the privacy that the traders receive. For example, massive institutions can trade in what’s known as a dark pool, a private trade between two investors in an off-exchange venue. In a dark pool, giant corporations will not know who they’re trading with, and everything will stay anonymous, including the transaction itself, which isn’t available to the public. This way of trading lets corporations trade large blocks of stock without the public seeing these trades and reacting by making the underlying security price more volatile.
Fourth Market
These markets are secretive and, for the most part, are only traded with the largest corporations. Unlike a dark pool, where the investors don’t know who they’re trading with, fourth markets let two corporations trade with each other privately. As a result, there is little known to the public on how fourth markets operate except that they trade amongst corporate institutions.
