After Hours Trading - Is it for you?

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“Alcoa (AA) Stock Declines Today in After-Hours Trading on Mixed Financial Results” and Royal Dutch Shell (RDS.B) Stock Flat in After-Hours Trading.  These headlines could be about any company and occur almost daily. They could signal any number of reactions from investors.

The advent of Electronic Communication Networks (ECN’s) now makes after hours trading available to everyone, but just because you can trade after hours, does not mean you should trade after hours.

As the manager of your own portfolio, you at least need to consider the advantages and disadvantages of trading before and after the bell rings. The daily volume of after-hours trading is normally miniscule when compared to the time from 9:30 to 4:00 but it provides savvy traders an opportunity to make moves that may not be evident during normal trading hours.  

After-hours volumes typically increase when a company announces their earnings or report merger and acquisition activity and experienced investors look for opportunities during these off hour times.

Why Would Anyone Want to Trade After Hours?

According to NASDAQ itself “investors find that after-hours trading activity provides a leading indicator for next-trading day activity as well as insight into Global Markets trading activity, as those markets start up within hours of the close of the U.S. after-hours market.

By watching what is happening around the world, many experienced traders are able to take advantage of changing conditions while the rest of us are having dinner or may not even be at our desks yet in the morning.

Three Types of After Hours Trading

There are actually two fundamental versions of “after-hours” trading. One is available 24 hours a day and the other is an extension of regular exchange hours.

  • FOREX - is the 24 hour version and requires and according to Investopedia requires a much better understanding of  the global economy – as they say, ”if you think it's difficult to value one company, try valuing a whole country! Fundamental analysis must now include an understanding of the socio-economic environments in which a prospective company is located. FOREX offers free practice accounts and we highly recommend trading FOREX on paper for a while before putting your money to work. FOREX brokers do not charge commissions, but make their money on “pips” or the spread between the purchase price, and the sell price of a security.
  • “Traditional” U.S. Exchange After-Hours Trading – most people think of after-hours trading as those trades that are executed from the traditional exchanges between 4:00 and 6:00 PM after the markets close.
  • Electronic Exchange Networks – beginning in1999, individual investors gained access to the networks that were previously reserved for institutional investors. Most discount brokers now offer some version of extended trading via ECN’s that extend the market day from 8:00 AM to 8:00 PM or from early morning hours like 7:30 to 9:15 and after the market closes from 4:00 to 6:00 PM.  

ECN’s Offer Unbuffered, Person to Person Trading

Unlike the NASDAQ and the NYSE where there are stringent reporting requirements enforced by the SEC, there is no common reporting structure for ECN’s.  

In the words of invest-faq.com, “it’s a jungle out there,” and just like in the shark infested waters of day time investing, there are plenty of wild animals ready to have you for breakfast and dinner. They report that “unlike the NYSE's specialist system and the NAQDAQ's market-maker system . . . the after-hours market will be quite different -- operations are quite literally in the dark.”

Essentially the buyers and sellers in the ECN markets are trading in private and the ECN is simply acting as an intermediary.

Other Subtleties and Nuances

As simple as it may seem at first blush, there are several nuances to after-hours trading that you will want to familiarize yourself with before “launching in.” Volumes are much lower so the odds of your order executing are limited. Be sure to set to sets stops and limits so you are not surprised with trades outside your anticipated range. Some brokerage firms charge more for after-hours trading. As always, make sure you understand the rules of engagement. You typically have less “visibility” into after-hours activity and therefore it is much more difficult to gauge how a stock is moving. Most after-hours orders expire when the after-hours market closes and do not carry over into “day orders.” Be sure you understand how your broker handles after-hours orders.

Who Uses After Hours Trading the Most?

Historically, experienced investors, hedge fund managers, banks and others who move large sums of money will often make their moves after hours when the rest of us are not actively watching the market.

The Risks Associated with After Hours Trading

The U.S. Securities and Exchange Commission (SEC) say that with the advent of ECN’s, less sophisticated investors now have access to after-hours trading and warns investors about the following risks:

  • Inability to see or act on quotesrealize that you are dealing with multiple ECN’s and what is available on one exchange may not be available on another.
  • Lack of liquidity – the ability to “consummate the deal” is limited because there are fewer buyers and sellers trading after-hours
  • Larger spreads – lower volumes also means higher spreads which also impacts the likelihood of a trade actually executing
  • Volatility – news stories announced after hours can dramatically move a stock price.
  • Uncertainty of pricing – some stocks may trade at different levels after-hours than during normal hours.

Summary and Conclusion

Portfolio managers are well served to understand the after-hours market and can benefit from news stories that occur when the markets are closed. If you want to trade 24x7, be prepared to learn about the socio-economic and political environments of the countries where you intend to invest.

Enter into the world of after-hours trading with your eyes wide open. Although it may seem like a more relaxed environment, it is actually quite the opposite. The sharks actively swim after-hours and will have you for dinner and breakfast.  They have resources that fully understand world economics at levels most of us will never see.

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