Secondary Market is the market everyone is talking about when they refer to the “stock market”. The New York Stock Exchange (NYSE), the NASDAQ, the S&P500 and all the other major exchanges around the world are part of the secondary market.
Essentially, the secondary market is where investors exchange previously issued securities among themselves without the involvement of the companies in question. For example, if you buy the Facebook shares today, you are purchasing the shares from another investor, not Facebook itself.
There are two special categories of the secondary markets: the auction secondary market and the dealer secondary market.
THE AUCTION MARKET
The auction secondary market can be summarized as a place where investors and institutions who wish to trade securities gather and announce the prices at which they are willing to buy (the bid price) and sell (the ask price).
Essentially, the theory behind the auction secondary market is that through these interactions, it efficiency prevails. This means that the convergence of buyers and sellers will bring out mutually agreeable prices. The New York Stock Exchange is an example of it.
THE DEALER MARKET
The dealer secondary market is different as it does not require the parties to converge. Instead, participants are connected through what is called electronic networks such as telephones, fax machines, or order-matching systems. The dealers, in this case, hold an inventory of the security, “make the market” and they earn profits through the spread between the prices at which they buy and sell securities.
The NASDAQ is an example of a dealer secondary market. Here, the dealers set generally firm bid and ask prices. Theoretically, the competition between dealers provides the best possible price for investors.
The last kind of secondary market you hear about often is the Over-The-Counter (OTC). The term originally referred to the off-Wall Street trading that exploded during the bull market of the 1920s, where shares were sold “over-the-counter” in stock shops and were not listed on a share exchange. However, over time the meaning of OTC began to change, first with the creation of the NASDAQ by the National Association of Securities Dealers (NASD) which sought to improve regulations on shares that were trading over-the-counter while bringing liquidity to companies. Now that the NASDAQ has evolved into primarily a major exchange and dealer market, it technically remains an OTC, but it does not trade unlisted securities.
Presently, “over-the-counter” still refers to shares that are not trading on a stock exchange but rather on either the Over-The-Counter Bulletin Board (OTCBB) or the pink sheets. These networks of brokers usually describe themselves as providers of pricing information for securities. These companies have fewer regulations to comply with than stocks that trade shares on a stock exchange. Generally, securities that trade OTC are penny stocks, companies with stock prices less than $1, or are from very small companies.