The stock market is one of the most fundamental components of the global economy, providing investors with unlimited trading opportunities. Today, investors have an even wider range of trading opportunities as they can sell or buy shares in unlisted companies through what is popularly known as a secondary market. Secondary markets have grown dynamically since the late 2000s when the Great Recession ended as a way of raising money for corporate growth and acquisitions. This means that a trader does not have to wait for new stocks released by companies in the new issues market, also known as the primary capital market. But what exactly is the secondary stock market, and how do investors trade shares in secondary markets? This guide discusses how you can buy or sell shares in private, unlisted companies on secondary market websites.
What is a Secondary Market?
The secondary stock market is what comes into the minds of most people whenever the term ‘stock market’ is mentioned. It refers to the market where investors trade already issued stocks. Proceeds from the trade go to the selling investor and not the primary issuing company.
How the Secondary Stock Market Work
When a company issues or sells shares directly to investors, the trade is said to have taken place in the primary market, and the issued stocks are known as primary offerings. Shares issued under the primary market are typically distributed to investors through an underwriting investment bank. Proceeds from this trade are received by the company issuing the shares after paying administrative fees owed to the underwriting bank.
If the investors who directly purchased the securities from the issuing company decide to trade their stake in the company, then they can do so through a secondary market. Trade in this market takes place between investors. While some of the secondary shares may be regulated, most of these stocks are do not have regulatory restrictions. Examples of secondary stock markets include the London Stock Exchange and New York Stock Exchange.
Types of Secondary Stock Markets
There are two common types of secondary markets, including Exchanges and Over the Counter markets.
Over the Counter (OTC) Markets
These are decentralized marketplaces where investors trade securities directly amongst each other without the involvement of a broker or central exchange. Since OTC markets do not have physical locations, trading stocks here is done electronically. Examples of OTC markets include OTC Pink, OTCQB, and OTCQX.
Exchanges are also decentralized marketplaces, where investors trade secondary stocks without direct contact. These trade venues are used as a way of ensuring trade fairness and efficient availability of price information for shares trading in these platforms. One of the disadvantages of exchanges is the high cost of exchange commission and fees.
How to Trade in Secondary Stock Market
Here is a step by step guide on how investors can trade in the secondary stock market.
Step One: Get a Reliable Trading Platform
Since secondary stocks are traded electronically, it goes without saying that you will need a trading platform to buy or sell shares in the secondary market. Since there is a wide range of companies offering brokerage services for stock trading, it is fundamental that you undertake due diligence on your broker of choice.
Here are factors to consider when choosing a trading platform.
Charges and Fees – Different brokers offer brokerage services at varying commissions and fees. Some will also require you to have a minimum deposit to have your trading account activated. Compare fees from various platforms to ensure that you pick the most affordable choice. High commissions and fees can reduce your profits to significant amounts, and sometimes resulting in losses.
Ease of Use – You need a trading platform around which you can manoeuvre and initiate your trade easily.
Wide Range of Trading Opportunities – Some of the leading giants in the trading industries are characterised by extensive investment options, enabling investors to diversify their portfolios. A reliable website should feature secondary shares, cryptocurrencies, bonds, penny stocks, forex, and other types of securities.
Customer Support – Your success in trading secondary shares through a broker is highly dependent on the level of customer support you receive whenever you have a need. Look for a website that offers active, 24/7 customer support.
Step Two: Decide on the Price and Volume of Your Trade
Once you have your trading account activated, you will need to decide on how much you are willing to trade in the secondary market. Most websites will offer price options on the Bulletin Board tab. However, it is important that you plan a trading budget that you will use to decide on the right price and volume for the trade.
When deciding on the price and volume of your trade, consider the following factors;
Graphical Statistics – When using a trading graph or chart, you can see whether the stock prices have been rising or falling in the recent past. Such information is helpful for your trade, as it will see avoid unnecessary losses.
Historical Returns – This is a highlight of what other investors have been gaining from their investment. A record of high returns should encourage you to take the risk of investing largely.
Demand for the Shares – When there is a high demand for specified stocks, the share prices increase, presenting promising opportunities to investors.
Dividend Yield – Shares represent the degree of ownership that a trader holds in a given company. The number of shares held by an investor also determines the number of dividends entitle to them. This is why it is fundamental to scrutinize the dividend policies of the issuing company, as this will influence the dividend yield you receive annually.
Step Three: Make an Offer
When you are ready to buy an underlying stock security, you can now make an offer via the trading website. This includes quoting the price that you are willing to pay for a security and the number of shares that you want to trade. Once you make the offer, you can now initiate trade.
Step Four: Trade Settlement
Trade settlement in secondary stock trading refers to the transfer of ownership of shares from the seller to the buyer. In this case, both the seller and the buyer are mandated to fulfil their trading obligations for the trade to be complete. This means that the investor must make the necessary payments for the shares to be transferred by the seller.
Benefits of Secondary Market Trading
Trading secondary stocks come with plenty of benefits to investors. Here is a brief outline of the advantages of secondary market trading.
Access to Shares in Fast Growing Unlisted Companies
Major stock exchanges, such as the NYSE and London Stock Exchange, are known for featuring giant public companies with large market capitalisation. However, small and growing companies in the private sector have also had a historical record of joining these exchanges in the long run. The advantage of purchasing shares from such companies is that you can spontaneously gain high returns on your investment, following their growing profits. This is where the secondary market comes in handy. Secondary stock markets give you access to small companies that are not listed in major stock exchanges yet have a high rate of growth.
Unlike a savings account where money is just held without earning any interest, investing in secondary stock markets allow investors to save their money as they generate returns. The secondary stock market earns you returns in two ways; capital gain and dividend yield. Capital gain is the profits investors generate for reselling their shares. On the other hand, the dividend yield is what you earn at the end of each year for owning shares in a company. The good thing with secondary stocks is that you do not need extensive capital outlay to get started.
When you decide to trade in the secondary stock market, you will find investment advisers, stockbrokers, and market participants who offer advice on matters pertaining to stock trading. This means that you do not necessarily have to be a stock market expert in leveraging your investment.
The concept of mobilising savings has become quite unachievable for most businesses and individuals, following the high liquidity of cash and bank savings. Investing in secondary stock markets, however, makes savings mobilisation a possible endeavour as stocks are less liquid than cash. It is, therefore, possible and easy to accumulate funds for a long-term project.
Sites Where Shares for Private Companies can be Traded
Technological advancement has made way to a rise in the number of trading platforms for secondary stocks. This section highlights examples of sites where shares for private, unlisted companies can be traded.
Schwab is a renowned brokerage company that provides investors with a wide range of secondary stocks, including the Pink Sheets and Over the Counter stocks. Schwab is also among the few companies that offer low-cost services for trade, with a commission of $4.99 for every trade. The broker offers investors with various trading platforms for their convenience, including a website, mobile app, and desktop application.
This is another leading company in the provision of high-quality trading services for secondary stock investors. TD Ameritrade features multiple securities, including forex, penny stocks, bonds, and other secondary stocks. Investors who subscribe to the TD Ameritrade platform enjoy free research tools, market monitoring tools, live cable news feeds, and other essential trading tools. You can also trade at any time of the day, as the platform is open for business for 24 hours for 5 days a week.
E-Trade has been in the brokerage business for over 38 years, featuring an extensive range of securities, including futures, ETFs, options, bonds, mutual funds, and secondary stocks. E-Trade charges $6.95 for each trade, with this amount cut down to $4.95 for completing 30 trades in a quarter. E-Trade has three trading platforms available to investors; mobile app, desktop app, and a website.
Fidelity is another reliable broker for secondary stocks, charging $4.95 for every trade. In addition to being one of the lowest-cost platforms for secondary stocks, Fidelity has an outstanding customer support system. In fact, before investors trade secondary stocks, they are required to call a Fidelity Rep to address possible risks. The platform features multiple accounts and securities, including OTC mutual fund, pink sheet stocks, and other stock assets.
Operational since 1982, TradeStation has become a popular trading platform for secondary stocks, providing services to multiple countries, such as the UK, Costa Rica, the United States, and Australia. TradeStation features research tools and technical analysis software that are designed to help investors in making informed trading decisions. With each trade going for $5, the platform is rated as one of the low-cost brokerages in the industry.
Risks Associated with Secondary Markets
While investing in secondary markets can be highly profitable, investors are also exposed to risks that could result in massive losses if not managed. Some of the risks associated with secondary markets include;
Counterparty Risk – This is the risk that one of the participants in a trade could default on their obligation.
Low Liquidity – Secondary stocks can become illiquid at certain periods of trade. With low liquidity, it becomes hard for investors to buy or sell stocks, resulting in losses.
Lack of Knowledge – Secondary stock markets, especially the OTC market, are unregulated. It is, therefore, impossible for investors to know the status of a company, exposing them to an extremely great risk.
Metrics to Use When Trading on a Secondary Market
To leverage your investment in a secondary market, the following are metrics that you should consider using;
This is the best metric to use when comparing the value of a stock with the earnings of a company. The P/E ratio establishes whether a stock is cheaper or expensive relative to other stocks in the market.
Return on Equity (ROE)
The primary driver of prices in the stock market is profits, which is what ROE seeks to establish. Basically, ROE is a measure of a company’s profits earned with shareholder equity.
Return on Investment (ROI)
This is considered to be the most fundamental metric for investors of any type of security, and secondary stocks are not an exception. ROI establishes how much a company has lost or gained on a specified investment.
Trading on the secondary market gives investors access to unlisted companies or other financial instruments. Investors with a high risk appetite can potentially generate high returns with secondary market offerings.