Most stocks are traded on an exchange, which effectively functions as a market where buyers and sellers can meet to exchange the fractional ownership that stocks represent. Just like any marketplace in real life, the stock exchanges have opening and closing hours which signify when trading is allowed on the exchange. On the New York Stock Exchange, the most recognizable of these exchanges, traders are alerted to the opening and closing by the famous ringing of the bell.
However, not all stocks are traded within that timeframe. For much of their history, many stock exchanges have allowed limited after hours trading which is not directly reported like regular trading. This was designed to be a limited timeframe both before and after regular trading that professional investors could use to make trades in bulk.
In 1975, the NYSE lengthened the trading day so that traders could buy and sell stocks until 4:00 PM, and since 1985, the beginning of regular trading hours has been 9:30 AM. Traditionally, most investors would make their trades within these times, but high net worth investors and large funds such as mutual funds and hedge funds have been allowed to trade stocks in extended hours. More recently, since electronic trades have become commonplace and smaller traders have been able to use electronic platforms through discount brokerages, more and more people have been able to trade before and after regular market hours.
Nowadays, these extended hours last from 7:00 to 9:30 am (for pre-market trading) and from 4:00 to 8:00 pm (for after-hours trading). All extended hours trades must take place within these time periods.
The Importance of Extended Hours Trading
Extended hours trading is fraught with dangers and pitfalls, but its benefits far outweigh its risks, especially for professionals and expert traders who know what they are doing. One of the biggest benefits with extended hours trading is that you can act instantly on recently released information. Several companies will announce their news before or after the trading day ends. If a company releases its earnings at 5:00 pm EST and those earnings are better than expected, investors who play the extended hours market can buy that stock at current prices before other market participants try to buy the stock and drive the prices higher.
This benefit works the other way, too; when disappointing or disruptive news happens, traders can respond immediately with a sell before prices fall significantly in response to the news. With more traders in the extended hours market, this kind of price divergence has been largely arbitraged out–meaning the prices tend to rise and fall more quickly as the market has gotten faster at responding to news–but there is by no means the instantaneous reaction that you see during regular hours.
The Dangers of Extended Hours Trading
The dangers with extended hours trading relate to the fact that there are less market participants and less arbitrage in the market. It is not uncommon for bid and ask prices to be substantially lower and higher (respectively) during pre-market and after-hours trading, as more and more extreme limit orders come to the exchange.
This means that making a buy or sell order at “market” can be devastating. You could wind up buying at a significant premium to the market or selling at a significant discount just because there are less buyers and sellers willing to buy or sell your stock. No trader worth his or her salt will ever put an extended-hours market order.
Conclusion
Extended-hours trading is an extremely volatile and risky exercise, and professional traders will only place limit orders in extended-hours. Sometimes, activity in extended hours will anticipate how a stock’s price changes during the regular trading day, but in most cases the lack of volume and wide spreads between bid and ask prices will often mean that extended-hours activity has little impact on the price action for the stock during the next session of regular trading. While it’s important to be aware of the risks and rewards of extended-hours trading, most investors will find that it’s better to make most of their trades during the day–especially if they are buying at the market price.