A stock market is a place where you can buy shares of various companies. But did you know that the stock market consists of two types of markets the primary market and the secondary market? While they are not separate markets, they represent different processes within the stock market, and together, they form the entire system.
What is the Primary Market?
When a company is created, the founders allocate a certain number of shares representing their ownership in the company. These shares can then be used to raise capital by offering them to the public through an Initial Public Offering (IPO) or a Follow-on Public Offering (FPO).
An IPO occurs when a company offers its shares to the public for the first time. On the other hand, an FPO happens when an already listed company issues new shares to raise additional capital.
Thus, when a company sells its shares directly to investors for the first time, it does so in the primary market.
What is the Secondary Market?
Once a company has issued shares through an IPO or FPO, those shares begin trading among investors. Shareholders who own these shares can sell them to other investors, or they can buy more shares from fellow investors.
This buying and selling of already issued shares happen in the secondary market, where the company itself is no longer involved in the transactions. Instead, investors trade shares among themselves, with prices fluctuating based on supply and demand.
Key Differences Between the Primary and Secondary Markets
The most significant difference between the two markets is that in the primary market, shares are offered to the public for the first time, whereas in the secondary market, shares that have already been issued are traded among investors.
In the primary market, the price of shares is usually fixed before they are offered to investors. In contrast, in the secondary market, share prices fluctuate based on demand and supply.
Another key difference is that in the primary market, shares are purchased directly from the company, meaning the company benefits from the capital raised. However, in the secondary market, shares are bought and sold among investors, so any profit or loss from the trade is gained by the investor, not the company.
In terms of intermediaries, the primary market involves underwriters, who help the company issue shares to the public. Meanwhile, the secondary market relies on brokers, who facilitate the buying and selling of shares between investors.
A company can only issue shares once through an IPO in the primary market, though it can later offer additional shares via an FPO. However, in the secondary market, shares that have already been issued can be traded an unlimited number of times.
The primary market is also known as the "New Issue Market," while the secondary market is often called the "Aftermarket."
Finally, since IPO and FPO transactions are relatively limited, the secondary market makes up a much larger portion of the stock market, as daily trading activity is significantly higher.