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I'm trying to understand some fundamentals of what it means to invest in the stock market. This question and the answers have been helpful to me:

Why does demand for stock rise when a company appears to have high future value?

That helps me understand the fundamental value of stock: ultimately each share of a publicly traded company represents ownership of a piece of the company. This is demonstrated concretely when, say, a private investor purchases the entire publicly traded company from the market. The board of directors - which represents the shareholders - and the acquisition company negotiate an agreed-upon price per share of the company. The private investor then pays each shareholder that price per share for the company. The private investor pays a price for each share that seems reasonable as a value for the talent of the employees and managers, the various buildings and assets of the company, the expected future profit stream of the company, etc. That is real concrete value and as a shareholder I own a piece of that value. Any given stock trade before any such corporate-wide acquisition (or liquidation) represents, on a much smaller scale, two investors doing the same analysis and agreeing upon a price for that share of the company.

All well and good. I feel I understand a bit better intrinsic value of stock.


My question now is: what value do I provide as a shareholder in the secondary market? In the primary market, things are pretty clear: a given business needs money and they choose to get money by "going public" and selling shares of the company. If I purchase these shares at that time, I get a share of their company, and in exchange they get my money with which they can invest and do greater things as a company.

The value of the shareholder after this initial offering, however, grows hazy for me. The following question and answer certainly makes the value to the said company seem pretty indirect:

How does the purchase of shares on the secondary market benefit the issuing company?

So let's take this a step higher, beyond the company whose shares are being traded: what value am I adding to the market when I buy stock after the initial IPO? How am I helping the market in general (and therefore society) by purchasing stock in the secondary market? I'd appreciate any help to clarify this.

  • Why the down vote? I appreciate constructive feedback. I cannot improve my questions if I do not know what is wrong with them. – firebush Jul 3 '18 at 21:30
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    Would you buy a stock on the primary market if there was no secondary market that would let you get your money back later? – The Photon Jul 4 '18 at 18:01
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Liquidity is the primary answer but it's useful to walk through why that's useful.

When the company sells stock on the primary market, investors are willing to pay more for a share because it is easy to sell than they would if there was no secondary market. The fact that there are a number of people willing to buy and sell the stock means that the investor can sell their shares with relatively low transaction costs at a fair price when they need the money in the future. Compare that to an non-liquid asset like a house where transaction costs are significant, where it takes months or years to complete a sale, and you will likely have to negotiate with potential buyers to get a fair price.

As a part of providing a liquid market, you help decrease the spread (the difference between the price a seller gets when they sell a share and the price the buyer pays) and you help the market define a "fair" price at any moment in time. When trading on the secondary market is sparse, the spread increases making transactions more expensive. And there is a much greater risk of market manipulation (i.e. penny stock scams where a bad actor drives up the price of a stock in order to dump it to unsuspecting investors).

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what value am I adding to the market when I buy stock after the initial IPO?

Liquidity.

How am I helping the market in general (and therefore society) by purchasing stock in the secondary market?

Liquidity.

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In addition to quid's answer of liquidity, you are aiding price discovery by buying stocks you consider undervalued and selling those you consider overvalued, so that other investors can transact at a fairer price. This includes the effect on the company itself, through the price at which it can perform secondary offerings or buybacks.

  • Interesting: by purchasing a stock at a price, I am a part of the system that determines the market value of a stock. Thanks. – firebush Jul 3 '18 at 21:27
  • Which is adding liquidity, you have added nothing extra. – Victor Jul 3 '18 at 21:28
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    @Victor I disagree -- various papers distinguish liquidity from price discovery (PD). Liquidity is the market's depth (large quantity bid/ask close together) allowing it to absorb large trades, but doesn't care what the price is. PD is about assimilating information to arrive at a "fair" price. Market makers directly provide liquidity but not PD since they don't make directional bets but react to public orders. Also, technically, hitting a bid/ask with a marketable order (as an investor might) removes liquidity. Liquidity is added with a limit order that sits between previous bid/ask. – nanoman Jul 3 '18 at 22:32

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