1.4 Secondary Financial Markets

For those eager students that want to learn about the stock market, this section is for you. In the previous section, we discussed primary financial markets, or the markets where securities are issued for the first time. Secondary financial markets are where securities are traded after the initial offering. Said differently, the secondary market for stocks is commonly referred to as the stock market. Markets are where assets are priced. For those who have taken any economics courses, you will remember that prices of any good or asset are determined by supply (the sellers) and demand (the buyers). The secondary market, particularly for stocks, is a fascinating market to watch prices change and move as supply and demand change in response to new information.

There are two types of secondary markets that we will discuss. The first type is an auction market. Those who have been to any type of auction before would have seen that an auctioneer will take bids from the public and sell to the highest bidder. Similarly, an auction financial market has a physical location, and prices are determined by the highest price an investor is willing to pay. The New York Stock Exchange (NYSE), the world’s largest secondary financial market, is an example of an auction market.1

The second type of secondary market is a dealer market. Unlike an auction market, a dealer market does not require a physical location. Instead, in a dealer market, securities are bought and sold through a network of dealers that trade for themselves. For example, a dealer might hold inventory in a particular stock and be willing to sell to those that demand the stock and buy from those that will supply the stock. NASDAQ, which is the second-largest secondary market in the world, is an example of a dealer market.2 Most stocks that are listed on NASDAQ have multiple dealers for each stock. The idea behind having multiple dealers providing liquidity to investors is that the dealers must compete with one another, thus lowering the cost of transacting.