Quick Answer
New securities sell in the primary market; everything after that trades in the secondary market, split into four categories by where and how the trade happens. Exchanges run an auction model with one price-setting intermediary; Nasdaq and OTC markets run a dealer model with multiple competing market makers quoting simultaneously.
The distinction matters because it determines who sets the price you see: a single auction process on an exchange, or competing dealer quotes off one.
Primary vs. Secondary Markets
- The primary market is where new securities are sold to investors for the first time (initial public offerings, new issues)
- The secondary market is where previously issued securities trade between investors
- Market makers and exchanges operate in the secondary market, providing liquidity for outstanding securities
Think of it this way: The primary market is the "factory" where securities are created, and the secondary market is the "used market" where they change hands afterward.
The Four Secondary Markets
The secondary market is subdivided into four categories based on where and how trades occur:
| Market | Description | Examples |
|---|---|---|
| First market | Trading on a national securities exchange | NYSE, Nasdaq |
| Second market | Over-the-counter (OTC) trading of securities not listed on an exchange | OTC Markets (OTCQX, OTCQB, Pink) |
| Third market | OTC trading of exchange-listed securities | Institutional investors trading NYSE-listed stocks OTC through broker-dealers |
| Fourth market | Direct institution-to-institution trading via electronic communications networks (ECNs), no intermediary | Dark pools, crossing networks |
- The third market allows institutional investors to trade exchange-listed securities OTC, bypassing exchange fees and gaining anonymity for large block trades
- The fourth market uses Electronic Communications Networks (ECNs) to match buy and sell orders directly between institutional participants
Exam Tip: Gotchas
The third market is specifically about exchange-LISTED securities trading in the OTC market. If a question describes an NYSE-listed stock trading through a broker-dealer off the exchange, that is the third market. A common mix-up is confusing the third market (exchange-listed stocks traded OTC) with the second market (unlisted stocks traded OTC). The key difference is whether the security is listed on an exchange.
Auction Market vs. Dealer Market
These are the two fundamental models for how prices are determined:
| Feature | Auction Market (Exchange) | Dealer Market (OTC) |
|---|---|---|
| Price discovery | Competitive bidding between buyers and sellers | Dealers quote bid and ask prices; trades occur at dealer quotes |
| Intermediary | Designated Market Maker (DMM) on NYSE maintains orderly market | Multiple competing market makers quote prices |
| Examples | NYSE, NYSE American | Nasdaq, OTC Markets |
| Execution | Orders matched through auction process | Customer trades against dealer inventory (principal) or dealer routes to another market (agent) |
Exam Tip: Gotchas
Nasdaq is classified as a dealer market, even though it is a national securities exchange. Multiple competing market makers post quotes on Nasdaq, unlike the NYSE where a single DMM is assigned to each security. The exam may ask which market uses an auction process (NYSE) vs. competing dealers (Nasdaq).
What Should You Check on Exam Day?
- Can you place a described trade into the right one of the four markets (first through fourth)?
- Do you know the third market is exchange-listed securities trading OTC, not unlisted securities?
- Can you identify whether a described venue is an auction market (NYSE, one DMM) or a dealer market (Nasdaq/OTC, multiple competing market makers)?