Buying Stock: Primary and Secondary Markets

There are two main markets where stock transactions are conducted. One is the primary market and the other is the secondary market. Each has different functions.

Primary market shares can be difficult to obtain. Decisions about the allocation of new shares are made by a company’s founders and owners and the investment banking firm underwriting the offering.

Any investor can buy shares of stock in the secondary market (as long as they’re available for sale) because at that point, shares trade openly in the public domain.

Key Takeaways

• When companies offer their first shares of stock to the public, the offering takes place in what’s called the primary market.
• These initial public offerings of stock are usually handled by underwriters on behalf of companies.
• The secondary market, or stock market, is where shares trade back and forth after an IPO.
• Secondary market investors have one business day to pay for their purchases.
• To allow a stock price to stabilize, company insiders who receive shares in the primary market usually can’t sell them in the secondary market for up to 180 days.

The Primary Market

Private companies become public companies when they issue new shares of stock to investors by way of an initial public offering, or IPO. This initial, or primary, offering is conducted in the primary market. It is the first sale of new shares of stock.

Usually, one or more investment banks/broker-dealers underwrite the issue. That means the bank or syndicate takes on the financial risk of buying the initial shares from the company and selling them to various investors (at a higher price).

The terms of the IPO indicate how many new shares will be sold to institutions and how many will be sold to individual (often wealthy) investors. Usually, these parties are clients of the underwriting firms.

Prices on the primary market are set prior to the IPO, so investors know how much they will pay for shares of a company’s stock.

This market is usually dominated by sophisticated and experienced investors, such as banks, pension funds, institutional investors, or hedge funds.

Note

Effectively, investors participating in the primary market buy stock directly from the issuing company. Investors within the public-at-large can then buy and sell the company’s stock when it starts trading in the secondary market.

The Secondary Market

The secondary market, commonly known as the stock market, is where investors buy and sell existing shares of stock from other investors. When you give your broker a stock order or enter it yourself online, its execution occurs in the secondary market.

Secondary market trading of IPO shares usually begins hours after the IPO is complete.

The proceeds of secondary market sales go to the selling investor, not to the company that issued the stock or to the underwriting bank. 

Stock prices in the secondary market fluctuate according to supply and demand.

The Shareholder

A shareholder is any individual or entity that has legal ownership of a company’s shares. For example, if you are a shareholder in Microsoft, your name is recorded as such on the books of Microsoft.

When you buy stock from another investor in the secondary market, the next business day, funds to pay for your purchase are moved from your account to the seller’s account. And securities are moved from the seller’s account to yours.

At that time, as noted above, your name will appear in the company’s record books, and you will be deemed the holder of record.

The investor from whom you purchased the shares will, at the same time, be removed from the records. They forfeit all associated rights to the shares, such as voting rights, and any dividends, distributions, or further capital gains (or losses).

How Can I Get Shares in the Primary Market?

Your broker may have access to IPO shares so talk to them if you’re interested in an upcoming offering. Bear in mind though that, frequently, the availability of IPO shares is restricted to institutional investors and wealthy, high-value individual investors.

Can I Sell Shares I Got in an IPO Immediately in the Secondary Market?

Not if you’re a major shareholder. Usually, company employees, founders, and owners, and shareholders with majority stakes, are required to hold IPO shares for a specific period of time (e.g., 90 to 180 days) before selling them. This is intended to keep immediate selling pressure from depressing the share price when shares first start trading in the secondary market. This lock-up rule is self imposed by companies that go public and is part of the terms of the IPO.

Do Shares Always Close Higher in the Secondary Market After an IPO?

No, they don’t. Investors often see excited trading of hot stocks immediately after an IPO. And prices can jump higher. However, where they trade and close depends on things like demand, market conditions, and investor outlook.

The Bottom Line

Investors buy shares of stock in the primary market and the secondary market. The primary market handles the initial offering of newly issued shares of stock from a company that is going public. The company sells these shares to specific investors.

The secondary market, or the stock market, is where shares are bought and sold after an IPO. These existing (no longer new) shares are bought and sold by any investor who wishes to own or dispose of them.