The secondary market is where you can purchase securities from the seller as opposed to the issuer of such a security. Hence securities that are initially issued in the primary market by companies are traded on the secondary market.
The secondary market comprises of broad segments such as Equity, Debt and Derivatives. Equity shares are the most widely traded form of securities. There are various ways in which equity shares are issued such as IPOs, rights issues and bonuses.
Who Are The Parties To The Transactions?
In the secondary market, there are basically three parties to a transaction. These are buyers, sellers and intermediaries between them.
The first two categories consist of retail investors, high net worth individuals (HNIs), Mutual Fund Houses, Corporate and Institutional Investors, Foreign Institutional Investors etc.
Retail investors are individual investors with limited access to funds. They park their surplus funds in equities to earn returns. Equity investments as an investment option for retail investors are considered to be high risk – high return proposals compared to other investment instruments like fixed deposits and post office schemes.
The term high net worth individual or HNI is used to refer to individuals and families that are affluent in their wealth holding and consequently have a higher risk profile. Its a relative term and its comprehension differs in different financial markets and regions.
Mutual funds pool up money of several investors and invest in various asset classes including equities. These returns are distributed among the investors in proportion of the Mutual Fund units held by them. This investment mode has gained a lot of popularity across the world. It is most suitable for investors who lack the skill and acumen to pick up good stocks.
Foreign Institutional Investors (FIIs) are venture capital funds, pension funds, hedge funds, mutual funds and other institutions registered outside the country of the financial market in which they take an investment exposure.
Mutual Funds and FIIs have gained a lot of importance as market participants as they have huge sums of money in their kitty to manage and are often instrumental in giving direction to the stock markets in the short term. Heavy buying or selling on their part plays a substantial part in market rise and fall.
Intermediaries such as stockbrokers, depositories, depository participants and banks facilitate payment of money in share transactions.
Brokerages are entities registered as members with the concerned stock exchange. In turn you, the investor, would be required to enroll with the broker. Brokers charge commission based fees for the services they offer. Sub brokers appointed by main brokers also offer the same services for a fee.
Depositories hold shares for investors in electronic form. Previously shares were held in physical form meaning that there were paper share certificates for shares held. This new system of holding shares through depositories reduces paper work and time and also does away with risks associated with physical certificates such as bad delivery, fake securities etc. There are two depositories in India, the National Securities Depositories Limited (NSDL) and the Central Depositories Services Limited (CDSL). These two depositories provide service to investors through their agents termed as Depository Participants (DPs). As per SEBI regulations, Banks, Financial Institutions and SEBI registered trading members can become DPs.
How Does The Secondary Market Function?
In order to understand how the secondary markets function we must first be apprised of certain important terms:
Price: - The price of a stock is totally guided by the forces of demand and supply. The share prices of liquid stocks with wide participation keep changing throughout the trading hours They can be tracked continuously on trading screens.
Circuit Filters: - Share prices can swing in a volatile manner on back of news or even due to rigging by operators. It is important to protect the interest of investors and guard them against major losses due to such volatile price movements. So stocks are subjected to an upper and a lower circuit. The price of the stock can move within this range only on a particular trading day There are various slabs like 2%, 5%, 10% and 20% circuit that different stocks are subjected to. The slabs are fixed depending on various factors like share price, retail share holding etc.
Volume: - The term volume refers to the total number of shares traded during the day Volumes can be calculated for a particular stock, an index or even for the entire exchange.
HOW TO TRADE
Financial markets provide their participants with the most favorable conditions for purchase/sale of financial instruments they have inside. Their major functions are:guaranteeing liquidity, forming assets prices within establishing proposition and demand and decreasing of operational expenses, incurred by the participants of the market.
Financial market comprises variety of instruments, hence its functioning totally depends on instruments held. Usually it can be classified according to the type of financial instruments and according to the terms of instruments’ paying-off.
From the point of different types of instruments held the market can be divided into the one of promissory notes and the one of securities (stock market). The first one contains promissory instruments with the right for its owners to get some fixed amount of money in future and is called the market of promissory notes, while the latter binds the issuer to pay a certain amount of money according to the return received after paying-off all the promissory notes and is called Stock market. There are also types of securities referring to both categories as, e.g., preference shares and converted bonds. They are also called the instruments with fixed return.
Another classification is due to paying-off terms of instruments. These are: market of assets with high liquidity (money market) and market of capital. The first one refers to the market of short-term promissory notes with assets age up to 12 months. The second one refers to the market of long-term promissory notes with instruments age surpasses 12 months. This classification can be referred to the bond market only as its instruments have fixed expiry date, while the stock market’s not.
Now we are turning to the stock market.
As it was mentioned before, ordinary shares’ purchasers typically invest their funds into the company-issuer and become its owners. Their weight in the process of making decisions in the company depends on the number of shares he/she possesses. Due to the financial experience of the company, its part in the market and future potential shares can be divided into several groups.
1) Blue Chips: Shares of large companies with a long record of profit growth, annual return over $4 billion, large capitalization and constancy in paying-off dividends are referred to as blue chips.
2) Growth Stocks: Shares of such company grow faster; its managers typically pursue the policy of reinvestment of revenue into further development and modernization of the company. These companies rarely pay dividends and in case they do the dividends are minimal as compared with other companies.
3) Income Stocks: Income stocks are the stocks of companies with high and stable earnings that pay high dividends to the shareholders. The shares of such companies usually use mutual funds in the plans for middle-aged and elderly people.
4) Defensive Stocks: These are the stocks whose prices stay stable when the market declines, do well during recessions and are able to minimize risks. They perform perfect when the market turns sour and are in requisition during economic boom.
These categories are widely spread in mutual funds, thus for better understanding investment process it is useful to keep in mind this division.
Penny stocks are designated as penny in terms of their market capitalization.
These might be low priced due to some reason such as these are of the companies looking for a way to raise capital. These might have good management, better future prospects but with insufficient funds due to which their share is low-priced. It is a matter of fact that a smaller company tends to grow faster and thus their stock tend to move at faster pace. With this Optimism in mind, don’t forget Penny stocks could be worth millions as well. So before underestimating them; keep it in your mind that it might be great opportunity turning your small capital into big amount
Penny stocks are considered more risky investments due to greater volatility factor. Secondly, these are generally traded in lots of 1000. So even if the price goes down by 1 buck, you will loose 1000 bucks in fraction of seconds. Thirdly, penny stocks might not be so frequently traded on stock exchanges. Suppose some rumor broke out and you just wish to exit the stock. But since the stock’s trading volume is low, you do not find buyers to buy your stock. Keeping aside all these factors, a well planned strategy might take you to diamonds hidden inside a coal mine. But before you really enter into the arena ask yourself few questions:
What is the price at which you must exit the stock?
Once decided upon the stock to buy, exercise your mind to know is it really worth buying? Below are the three criterion helping you take a final decision.
Company fundamentals: Good cash flow is the most important consideration in choosing a penny stock. Spare sometime in knowing company fundamentals in addition to its goodwill and future projects. If a company has a good chance of success, please go for it.
PE and PEG ratio examine the PE ratio of the stock you and compare it with its peers doing well in the market. A safer way however is to find out the Price/Earnings/Growth (PEG) ratio (PE ratio divided by the projected growth in the next 3-5 years). Remember you will choose a stock with higher PE but lower PEG.
Trading volume: Assume yourself in a situation when you want to sell your stock but no one is ready to buy it. Stocks with low liquidity are difficult to buy or sell for the prices you want. So think twice before you buy such stock.
That was all about the reasons for you to buy a penny stock and considerations while deciding which one to buy? But the story does not end here due to associated risks. The best strategy to minimize the risk is to plan your exit having decided your expected profits. Do not just pump and dump the stock for reason that it costs you less than other stocks and will reach very high levels one day.
Shares can be issued both within the country and abroad. In case a company wants to issue its shares abroad it can use American Depositary Receipts (ADRs). ADRs are usually issued by the American banks and point at shareholders’ right to possess the shares of a foreign company under the asset management of a bank. Each ADR signals of one or more shares possession.
When operating with shares, aside of purchase/sale ratio profits, you can also quarterly receive dividends. They depend on: type of share, financial state of the company, shares category etc.
Ordinary shares do not guarantee paying-off dividends. Dividends of a company depend on its profitability and spare cash. Dividends differ from each other as they are to be paid in a different period of time, with the possibility of being higher as well as lower. There are periods when companies do not pay dividends at all, mostly when a company is in a financial distress or in case executives decide to reinvest income into the development of the business. While calculating acceptable share price, dividends are the key factor.
Price of ordinary share is determined by three main factors: annual dividends rate, dividends growth rate and discount rate. The latter is also called a required income rate. The company with the high risks level is expected to have high required income rate. The higher cash flow the higher share prices and versus. This interdependence determines assets value. Below we will touch upon the division of share prices estimating in three possible cases with regard to dividends.
While purchasing shares, aside of risks and dividends analysis, it is absolutely important to examine company carefully as for its profit/loss accounting, balance, cash flows, distribution of profits between its shareholders, managers’ and executives’ wages etc. Only when you are sure of all the ins and outs of a company, you can easily buy or sell shares. If you are not confident of the information, it is more advisable not to hold shares for a long time (especially before financial accounting published).