The stock market is interpreted by most beginners as buying and selling shares through apps like Zerodha or Groww. This is a common misconception. The stock market is actually split into two major segments: the primary market and the secondary market. You must know the difference if you wish to invest successfully and avoid pitfalls.
In this guide, we will help you understand the primary market, secondary market, the difference between primary & secondary, what an IPO is, what the different types of stock markets are and what market intermediaries are, all in simple language.
Stock Market Types
A stock market opens a pathway of communication between two kinds of parties: companies that need money, and investors who want to grow wealth. Multiple types of stock markets are identified, yet they can all be summarised into two categories:
1. Primary Market
2. Secondary Market
The two can be combined to create a functioning stock market. Primary and secondary do not offer the same service. They are equally important. We'll explore what each of them provides, step by step.
What Are Primary Markets?
IPO meaning - The market where freshly issued securities are first offered for sale is known as the primary market. A corporation uses the primary market to raise money from investors when it needs to expand, pay off debt or make new investments.
What is an IPO?
The most famous example of the primary market is an IPO because it is the first time a company goes public. An IPO is the first time a private company becomes public because it sells shares to investors. Other ways businesses collect funds in the primary market are through:
- Follow-on Public Offer (FPO).
- Rights Issue.
- Preferential Issue.
- Private Placement.
How Do Primary Markets Operate?
In primary markets, a company can raise funds by implementing the following steps:
1. A business is actively seeking funds from the public.
2. They hire market intermediaries such as investment banks and underwriters.
3. The company submits its offer documents to the regulators.
4. Shares are sold to investors at a predetermined price or price range.
5. Investors have to apply for shares.
6. Investors' demat accounts receive the credits for the allocated shares.
7. The raised money goes directly to the company.
Characteristics of a Primary Market
- Initially, new shares can be given out.
- For creating a business, capital is acquired.
- The company is the initial seller of the shares to investors.
- The price can be either set or determined through the book building process.
- Although the risk is significant, the eventual prospects can be quite positive
What is the Secondary Market?
In the secondary market, investors buy and sell already issued securities. This is what most people refer to as the stock market. In the secondary market, the money is not given to the company. Instead, money is exchanged between investors.
The National Stock Exchange and the Bombay Stock Exchange are examples of platforms for secondary market trading.
How the Secondary Market Works
In secondary market trading, the steps are as follows:
1. Shares for a company are already listed on a stock exchange.
2. Through brokers, investors submit buy/sell orders.
3. Orders are electronically matched.
4. Money is settled and shares are transferred.
5. Based on demand and supply, the prices continuously change.
Important Characteristics of The Secondary Market
- Trade of pre-owned shares.
- High liquidity.
- Daily price changes.
- Self-investors swapping shares.
- Aiding in discovering prices.
- Provides entry and exit with ease.
Primary vs Secondary Market: Key Differences
|
Basis |
Primary Market |
Secondary Market |
|
Meaning |
Market for new securities |
Market for existing securities |
|
Purpose |
Capital formation |
Liquidity & trading |
|
Buyer |
The investor buys from the company |
An investor buys from another investor |
|
Seller |
Company |
Existing shareholder |
|
Price |
Fixed or discovered |
Market-driven |
|
Risk |
Higher uncertainty |
Comparatively lower |
|
Example |
IPO, FPO |
Buying shares on the exchange |
The above table gives a simple and clear explanation of the differences between primary and secondary markets.
Function of Market Intermediaries
Market intermediaries are essential in both markets. They provide the system's efficiency, transparency, and protection to the investor.
Market Intermediaries in the Primary Market
- Investment banks.
- Legal advisers.
- Underwriters.
- Registrars.
- Auditors.
They assist in the structuring of issues, pricing of shares, and the regulatory compliance and management of applications.
Market Intermediaries in the Secondary Market
- Brokers.
- Depository participants.
- Clearing corporations.
- Custodians.
- They assist in the buying, selling, settlement and safekeeping of securities.
Importance of the Primary Market
- Enables companies to raise capital.
- Fosters economic growth.
- Creates new avenues for investment.
- Promotes the spirit of entrepreneurship.
Importance of the Secondary Market
- Gives investors liquidity.
- Facilitates fair price discovery.
- Enhances the confidence of investors.
- Facilitates portfolio rebalancing.
- Companies cannot grow without the primary market and investors cannot exit without the secondary market.
Risk Comparison: Primary vs Secondary Markets
- The primary market has more risk than the secondary market, as the fundamentals of the company are not tested in public markets.
- Risk in the secondary market is more price volatility, market sentiment, and economic conditions.
- People with a long-term outlook tend to take part in IPOs, while traders and active investors go for the secondary market.
Who Should Invest Where?
Beginners: Begin with secondary market investing using mutual funds or investing in large-cap stocks.
Long-term investors: After research, invest in selective IPOs.
Traders: Only the secondary market.
Wealth builders: Both markets.
Myths about Primary and Secondary Markets
- IPOs guarantee listing gains.
- Only experts can navigate the secondary market.
- Primary markets are risk-free.
- There are too many complicated types of stock markets
- Understanding the basics of investing can eliminate these misconceptions.
Conclusion
The secondary and primary markets are the backbone of the stock market. The primary market allows investors to create new stock offerings, like IPOs, while the secondary market allows investors to trade stocks on a regular basis.
A knowledgeable investor understands what primary vs secondary market means, the meaning of an IPO, the different types of stock markets and what market intermediaries do before investing. When fully utilized, both markets can offer disciplined strategies to create sustained wealth.
