All trading involves risk. Ensure you understand those risks before trading.
All trading involves risk. Ensure you understand those risks before trading.

Secondary market: definition, types and examples

Article By: ,  Former Senior Financial Writer

Stocks and bonds trade on primary and secondary markets. Most retail traders have access to the latter. Let’s take an in-depth look at secondary markets.

What is the secondary market?

The secondary market is where investors can buy and sell securities between each other, rather than the issuing entity. It’s secondary to the primary market, where stocks and bonds are sold for the first time by issuers to investors.

In a primary market, the issuers can set their own prices. But in the secondary market, prices are driven by supply and demand. For example, if traders believe in the future of a company and buy its stock, its share price will rise.

Who trades on the secondary market?

Entities and individuals that trade on the secondary market include:

  1. Retail investors
  2. Brokers
  3. Financial intermediaries – such as trading providers
  4. Institutions – such as insurance companies, banks and mutual funds

What instruments trade on the secondary market?

The instruments that trade on secondary markets include equities – such as shares and exchange traded funds (ETFs) – as well as fixed-income instruments, such as bonds.

While commodities and forex also trade in public marketplaces, they’re not classed as secondary markets given that there’s no primary issuance.

How does the secondary equity market work?

A secondary market works through various platforms and marketplaces, which gives the shareholders of a company – whether they’re individuals or institutions – the chance to sell the shares to another investor.

Usually, investors in the primary market can’t liquidate their positions in the secondary market immediately. There’s often what’s known as a ‘lockup period’ before transactions can occur – typically of 90 or 180 days.

The secondary market serves a few vital purposes:

  1. Accessibility – retail traders and investors can trade shares not just institutions
  2. Liquidity – trading shares is easier and faster in secondary markets given the greater number of participants
  3. Transparency – all transactions on the secondary market are stored in order books, making them visible to other market participants
  4. Accountability – public companies have to disclose information about their earnings and finances

Is a stock exchange a secondary market?

Yes, a stock exchange is a secondary market. These are the public marketplaces for buying and selling the shares of companies, as well as ETFs.

Examples include New York Stock Exchange (NYSE), London Stock Exchange (LSE) and Australian Stock Exchange (ASX).

Buying and selling shares on the secondary market

You’d buy or sell shares on the secondary market based on your prediction of whether a stock will rise or fall in value.

  • You buy, or go long, if you think that a share price will rise
  • You sell, or go short, if you think that a share price will fall

You can open a trading account with City Index to take a position on stocks via CFDs. Alternatively, you can open a risk-free demo account to build your confidence with virtual funds first.

What is the secondary market for bonds?

The secondary market for bonds is where contracts are bought and sold between investors through brokers, without the issuer’s involvement.

Although it works in much the same way as stocks, the difference is in the factors that impact their pricing.

While bond prices and yields fluctuate in line with supply and demand, the contracts have fixed principals (initial investment) and coupon rates (interest paid at fixed intervals throughout the contract’s maturity). So, generally bonds are less volatile than stocks unless rates change.

If interest rates rise, the price of bonds on the secondary market usually falls, as newer issues come with greater incentives for investing – decreasing the demand for the older bonds. This is known as interest rate risk. The longer the duration of a bond, the more sensitive its price is to changes in interest rates, as there is a greater chance it will be exposed to the risk.

Conversely, if rates fall, the price of bonds on the secondary market will usually rise, as the higher interest rates become more attractive.

How are bonds traded on the secondary market?

Most bonds on the secondary market will be traded through exchanges, and facilitated by stockbrokers and banks.

As bonds are essentially loans from investors to governments or corporations, when the contracts are traded on the secondary market, all the terms of the agreement are transferred from the original holder to the new buyer.

The transactions will be recorded so that the issuer can keep track of who they owe capital to.

Why should a bond issuer care about secondary market liquidity?

When bonds trade on the secondary market, issuers should still pay attention given it is a direct indicator of confidence in their ability to repay their loans.

A bond that is trading below its intrinsic value on the secondary market means that there are doubts about the issuers’ ability to uphold their obligations. This can make it more difficult for the issuer to refinance at better terms with banks or other lenders, and secure loans in the future.

Apart from those more direct impacts, a lower bond price can impact a company or government’s reputation.

For example, the UK government announced plans to cut tax in September 2022 as part of its trickle-down economics policies. In theory, this should have increased investment in UK bonds as yields would need to be raised too.

But the credit agency Moody’s stated that the unfunded tax cuts were credit negative and would permanently weaken the UK’s debt affordability. The market sentiment soured and forced the UK government to abandon its plans.

Buying and selling bonds on the secondary market

In much the same way as shares, you’d buy or sell bonds on the secondary market based on your prediction of whether the asset will rise or fall in value. While corporate bond prices are based on the belief in the underlying company, government bond prices are dependent on the reputation of the economy.

  • Buying, or going long, means you think that a bond price will rise
  • Selling, or going short, means you think that a bond price will fall

You can open a trading account with City Index to take a position on bonds via CFDs. Alternatively, you can open a risk-free demo account to build your confidence trading bonds with virtual funds first.

From time to time, StoneX Financial Pty Ltd (“we”, “our”) website may contain links to other sites and/or resources provided by third parties. These links and/or resources are provided for your information only and we have no control over the contents of those materials, and in no way endorse their content. Any analysis, opinion, commentary or research-based material on our website is for information and educational purposes only and is not, in any circumstances, intended to be an offer, recommendation or solicitation to buy or sell. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. No representation or warranty is made, express or implied, that the materials on our website are complete or accurate. We are not under any obligation to update any such material.

As such, we (and/or our associated companies) will not be responsible or liable for any loss or damage incurred by you or any third party arising out of, or in connection with, any use of the information on our website (other than with regards to any duty or liability that we are unable to limit or exclude by law or under the applicable regulatory system) and any such liability is hereby expressly disclaimed.

City Index is a trading name of StoneX Financial Pty Ltd.

The material provided herein is general in nature and does not take into account your objectives, financial situation or needs.

While every care has been taken in preparing this material, we do not provide any representation or warranty (express or implied) with respect to its completeness or accuracy. This is not an invitation or an offer to invest nor is it a recommendation to buy or sell investments.

StoneX recommends you to seek independent financial and legal advice before making any financial investment decision. Trading CFDs and FX on margin carries a higher level of risk, and may not be suitable for all investors. The possibility exists that you could lose more than your initial investment further CFD investors do not own or have any rights to the underlying assets.

It is important you consider our Financial Services Guide and Product Disclosure Statement (PDS) available at www.cityindex.com/en-au/terms-and-policies/, before deciding to acquire or hold our products. As a part of our market risk management, we may take the opposite side of your trade. Our Target Market Determination (TMD) is also available at www.cityindex.com/en-au/terms-and-policies/.

StoneX Financial Pty Ltd, Suite 28.01, 264 George Street, Sydney, NSW 2000 (ACN 141 774 727, AFSL 345646) is the CFD issuer and our products are traded off exchange.

© City Index 2024