Welcome to another podcast by Angel One.
Today we are discussing something that is both important and interesting.
As an investor you must be quite familiar with the terms primary and secondary markets.
Primary markets are where securities are created. In these markets, companies offer up their shares to the general public for the very first time. And investors purchase shares that have never been traded before. You must have heard about Initial Public Offerings or IPO. IPOs are an example of the primary market.
In primary markets stocks are purchased directly from the issuing companies.
Secondary market is also understood as the stock market. Here, investors trade amongst themselves. The issuing company has minimal to no involvement. The Bombay Stock Exchange (BSE), National Stock Exchange (NSE), New York Stock Exchange (NYSE), NASDAQ- they are all examples of secondary markets where traders buy and sell securities.
But did you know that apart from primary and secondary markets there are two more types of markets? They’re known as the third and fourth markets. Today we’ll be discussing third markets.
So what is a third market and how do people trade on it?
In a third market, stocks listed on stock exchanges are traded electronically and over-the-counter (OTC). By trading on the third market you essentially skip the participants of the secondary market such as stockbrokers and stock exchanges. Charges like processing fees, commissions, brokerage fees, turnover fees that are associated with trading on stock exchanges can be avoided easily. For this reason, the total price of each share is much lesser than on exchanges.
This might make you think, who all conduct trading on third markets?
Usually the third market is preferred by big institutional investors such as hedge funds, endowments and investment banks, etc. Institutional investors are companies that make investments on behalf of their clients. These companies often conduct bulk trades, which means they purchase or sell a massive amount of securities all at once. But they are not the only ones participating in these third markets. Of late, many high-net worth individuals are also known to take part. Basically if you possess the purchasing power to conduct bulk deals, you may trade in third markets. Cool, isn’t it?
But why do these institutional investors prefer the third market?
When you throw a party at your home, you need to do shopping, right? You make a shopping list and take a trip to the local grocery stores or order online. But when there is a much bigger function being organized, such as someone’s wedding, then you usually prefer catering services because they take care of all food arrangements. Now these catering companies do not shop in the same supermarkets as you do. They get their supplies from wholesale vendors. Items bought in bulk from wholesale markets cost much less than they do in supermarkets. This is because individual buyers usually have to pay the logistics, maintenance, service, and other small added up costs per item. Try to understand third markets as such a wholesale market.
One thing is simple- trading costs in third markets are low. These bulk deals include thousands of shares being bought, and they can be valued in millions. And the brokerage, tax, turnover fees, etc. for these high-value transactions run in tens of thousands.
This increases the average cost per share, for sure. But if we zoom out a little bit, we can see that due to these charges, the potential gains can become significantly low, too.
You might think, these charges often are very low. How can they possibly be an important deciding factor? Let’s do some calculations of our own to figure it out.
Imagine you are an institutional investor and want to purchase 1 lakh shares of XYZ company. It is a company listed on the exchange and each of its shares are priced at 100 rupees. The cost of the shares for you are 100 lakhs rupees.
But consider that the fees for trading on exchanges amount to 5%.
The amount of these fees would be 5% of 100 lakhs, that is 5 lakhs.
This increases the price per share. 100 lakhs + 5 lakhs, that is 105 lakhs divided by 100 shares, equals Rupees 105 per share. That is 5 rupees more per share!
Such a situation can be avoided by trading on third markets.
In third markets, buyers and sellers both can maintain complete anonymity. This works well for institutional advisors that do not want to share information about their investments with the public. Bulk deals can also cause unprecedented spikes in price action, leading to moments of volatility in the market. By conducting such deals in the third market, the stress to markets and retail investors are minimised.
That’s all about third markets. To know more about trading in stocks, www.angelone.in.
As usual, happy investing!