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Secondary markets and their types

Secondary markets are markets in which investors trade securities primarily with each other. They are important for well-functioning primary markets because investors value liquidity.

Call markets vs continuous markets

Secondary markets are either call markets or continuous trading markets. Call markets are typically arranged once in a day where all sellers and buyers meet, and a single market-clearing price is determined which generates the most volume. In continuous markets, trades can be arranged at any time.

Many markets start as a call market and switch to continuous trading while others trade continuously and then close through a call.

There are three types of markets based on execution mechanism: quote-driven, order-driven and brokered.

Quote-driven markets

Quote-driven markets (also called price-driver or dealer markets or over-the-counter (OTC) markets) are markets in which customers trade with dealers who quote a bid-ask price. Almost all bonds and currencies trade in quote-driven markets.

Order-driven markets

Order-driven markets are markets in which stock exchanges and ECNs use rules to match buy and sell orders. Two types of rules are important: order matching rules and trade pricing rules. In an order precedence hierarchy, the rule that specifies orders are closed first depends primarily on price priority but other factors such as display size and timing are also important.

There are three types of trade pricing rules:

  • uniform pricing rule, which primarily applies to call markets, settles trades at a single price which maximizes trading volume;
  • discriminatory pricing rule, which applies to continuous markets, allows an arriving trader to match the most aggressively priced order first and so on; and
  • derivative pricing rule, which applies to the crossing networks, derives trading price from another market in which the security principally trades.

Brokered markets

Brokered markets are markets in which brokers arrange trade among their clients. Brokered markets are common in the case of unique assets such as real estate, antiques, paintings, etc.

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