Extended hours trading is not for the faint of heart. It is a type of trading activity that is dominated by large institutional traders. While individuals can take part in this activity, institutional traders have a natural advantage. However, astute traders have greater opportunities for profit.
Extended hour trades present traders with unique advantages, but they also carry high risks. If you would like to engage in extended hours trading despite the level of risk involved, you need to do some research on different stock exchanges, closely monitor stock prices, and learn about your competition.
Here are some key takeaways:
- The two types of extended hours trading are pre-market trading and after-hours trading.
- Most extended hours trading generally occurs close to normal trading hours.
- News that affects stocks occurs shortly before or shortly after open or close.
- There is generally a lower volume of stocks during extended hours, which leads to increased volatility.
What Is Extended Hours Trading?
Extended hours trading is a type of market activity that occurs before or after the trading day of a stock exchange. Extended hours trading is also known as electronic trading hours, or ETH, because it occurs with the help of Electronic Communication Networks (ECNs).
Regular trading hours for major exchanges in the United States, like the New York Stock Exchange and Nasdaq, generally begin at 9:30 a.m. and end at 4:00 p.m. Eastern Time (ET). Pre-market trading or ETH that occurs before the trading day generally starts around 4:00 a.m. ET and ends by 9:00 a.m. ET. After-hours trading or ETH that occurs after normal trading hours begins at 4:00 p.m. ET and ends at 8:00 p.m. ET. Normal and extended trading hours may vary, depending on the exchange and the asset or security that is being traded.
Most extended hours trading occurs around 6:30 a.m. ET on a trading day. By then, investors have time to react to the news that affects stocks, and stock prices are closer to normal.
When Did Extended Hours Trading Begin?
Since 1985, regular trading hours for major exchanges in the U.S. were set to their current schedule, but extended hours trading would not exist for another 14 years. In 1999, extended-hours trading began as ECNs were introduced to allow traders to invest without being on a stock market floor to place a trade.
At first, ETH was limited to investors that had a high net worth and institutional investors, such as mutual funds. However, ECNs eventually allowed individual investors to engage in after-hours trading as well.
What Are the Advantages of Extended Hours Trading?
There are several potential advantages of extended hours trading. First, electronic trading can be convenient. Investors who may not otherwise be able to take part in the stock market can invest in their own time. Secondly, traders can instantly react to the news that affects a stock to take advantage of favorable prices. Generally, bad news about a company may cause its stocks to drop sharply, which will lead to quick selloffs. Astute buyers can pick up certain stocks on the cheap.
What Are the Risks of Extended Hours Trading?
There are generally more risks associated with extended hours trading:
- There is less trade volume during extended trading. This means that it is harder to execute trades outside of normal market hours.
- There are wider big-ask spreads during extended hours. This may lead to unfavorable prices for the buyer.
- The lack of trade volume and wider bid-ask spreads outside of normal market hours lead to increased price volatility. The risks are especially pronounced in after-hours trading, which is generally when the worst news about companies happens.
- The increased volatility during extended hours means that the price of a stock is uncertain. This is a bigger problem for after-hours traders. The prices of securities tend to settle during pre-market hours and resemble prices investors may see during normal market hours.
- Extended trading participants tend to be large institution investors, like mutual funds. Since large institutions have a vast wealth of resources, it is harder for individuals to profit outside of normal market hours.
Limits on Extended Hours Trading
Now, most brokers put limits on traders outside of normal trading hours. For one thing, traders are required to enter limit day orders during extending trading sessions because market orders are riskier due to the decreased liquidity. Also, most brokers only allow traders to offer Regulation National Market System securities and bar over-the-counter securities, many funds, and some options. Certain markets may not be accessible outside normal trading hours.
Here are a few pertinent terms regarding extended hours trading:
- Asset: An asset is a resource that contains economic value and that is owned by an individual, company, or government. An asset may provide its owner with a future monetary benefit, especially if it can generate cash flow or reduce expenses.
- Bid-Ask Spread: This is generally the difference between what a buyer is willing to pay for a market asset and the lowest price that a seller will accept for that asset.
- Electronic Communication Network: An ECN is a computerized system that instantly matches buy and sell orders for securities for trade in a market. When individuals use ECNs, they can directly trade between major brokerages over a geographic distance. Someone can simply place an order to buy a certain number of shares at a specific price, and an ECN will look for such a sell order.
- Exchange: An exchange is a marketplace where investors can trade financial instruments (like stocks and bonds) and commodities. An exchange can be a physical location or an electronic platform. Exchanges are governed by rules set by various government agencies to ensure fair trading and transparent pricing. Governments, companies, and groups can use exchanges to offer securities to investors.
- Foreign Exchange: The foreign exchange (which is also referred to as forex or FX), is a transaction that occurs when someone trades one currency (like the dollar) for another (like the yen).
- Forex Market: The foreign exchange market is where currency swaps take place. The foreign exchange market has no central location, but it consists of an electronic network of banks, brokers, institutions, and traders. The forex market is also the largest in the world, so it has the most liquidity.
- Liquidity: This refers to the ease with which an asset or security can be converted to cash. The liquidity of a market increases with more activity since more investors are putting their money into it.
- Market Order: A market order is a request by a trader to buy or sell a stock at the best current price. Such an order is often made through a broker or brokerage service, and it’s the fastest way to enter or exit a trade.
- Regulation National Market System: This is a set of rules established by the Securities and Exchange Commission (SEC) with the intent to improve exchanges, promote competition, and establish fair market pricing.
- Security: A security is a financial product that holds economic value. It may represent ownership in a publicly traded company, a creditor relationship in a government, or the right to ownership, as with an option.
- Volatility: In securities trading, volatility refers to the big swings a stock’s price takes over a sustained period in either direction.
How to Make the Most of Extended Hours Trading
Day traders who prefer to do most of their trading during normal hours can use extended hours trading to help them analyze stocks. Instead of acting on the stock during the hours before most exchanges open, traders can analyze a few economic indicators to predict how certain stocks may perform for much of the day. Most of this information is released at 8:30 a.m. ET, one hour before the stock exchange opens on Friday. For example:
- The Economic Situation Report is considered the most important economic indicator for traders. The information in the report lets traders know basic information about who is employed. That information includes demographics, data on which industries have lost employees, and data that shows how buying power has shifted among the public.
- Investors use the “corporate profits” and “inventory” data from the Gross Domestic Product (GDP), often from different countries, to predict which economies are experiencing fast growth.
- The jobless claims report is generally used by investors to gauge the general health of the economy. Investors look at who has claimed unemployment benefits during a given period, and the increase or decrease in claims will generally have an inverse effect on the market.
Of course, none of these indicators can allow investors to perfectly predict which assets and securities to buy and sell, but these are still leading indicators.
Ultimately, trading comes with a set of risks, but extended hours trading holds some of the greatest risks for investors. To make the most of extended hours, investors must be aware of the risks, the limitations placed upon them by brokerage firms, and analyze common economic indicators. If you would like to know more about extended hours trading, look to the experts at Raging Bull. They’d be glad to help you define a good day trading strategy.