What is after-hours trading?

After-hours trading (AHT), also known as extended hours trading, is the buying and selling of securities after the major markets have closed. This kind of trading around the clock has been made possible by electronic communication networks (ECNs), which allow direct trading to be done digitally – and even anonymously – without brokers.

Key takeaways

How does after-hours trading work?

When you see someone ringing the opening or closing bell on the New York Stock Exchange (NYSE), it’s easy to imagine that markets have fixed trading hours. There certainly are standard trading hours – which in the US are from 9.30am to 16.00pm ET. 

Trading during these normal hours of operation is characterised by high liquidity, meaning there are a large number of market participants making it easier for investors to buy and sell securities at a good price. And the competition and high volume of transactions during standard trading hours means the price swings of stocks will tend to be smaller too.

However, in recent years it has become increasingly common for both big investors and individuals to continue trading securities after hours. There are two sessions during which this takes place:

• An afternoon session from 16.15pm to 20.00pm.

• A morning session from around 8.00am until 9.15am.

A little premarket trading is also done as early as 6.00am on normal trading days. Some traders and investors watch this premarket trading closely to gauge the market’s direction ahead of regular trading hours. But the limited trading volumes can give a false impression of a stock’s strength or weakness, and only highly experienced traders are advised to consider premarket trading.

Electronic communication networks

After-hours trading was the development and spread of electronic communication networks (ECNs) that encouraged take-up of AHT. ECNs are automated systems linking traders with major brokerages, enabling them to trade securities from different geographic locations and without needing a stock exchange as a middleman. As so often, technology has lifted barriers and made things possible that weren’t possible before.

Originally, AHT was mainly practised by institutional investors. Electronic communication networks allow these big institutional investors to interact anonymously and conceal their positions. 

However, over the last two decades, ECNs have become more prevalent and user friendly, and some are now specifically designed for the needs of retail investors. Examples of ECNs include Instinet, SelectNet and NYSE Arca – the latter of which enables electronic trading on the NYSE and Nasdaq.

Nasdaq 100 After-hours indicator

The growth of AHT raised another issue: initially, there weren’t many information sources available to help investors gauge market sentiment during after market trading. Effectively, all investors could do was observe trading activity in individual securities.

But now there’s a Nasdaq 100 after-hours indicator (AHI), which serves as an index of Nasdaq 100 trading activity during the after-hours market, from 16.00pm to 18.30pm ET. Additionally, there is a Nasdaq-100 pre-market indicator (PMI), an index of trading activity based on pre-market open prices from 4.00am to 9.30am ET.

Both the AHI and the PMI are minute by minute calculations, using the same methodology that’s used for the Nasdaq-100 Index during regular market hours. If stocks aren’t trading after hours, their prices stay at the daily close.

Pros and cons of after-hours trading

There are several potential benefits for after-hours trading:

• Flexibility. Some traders’ schedules don’t allow them to trade during normal hours. With after-hours sessions they can check place trades at times more convenient to them.

• Ability to react to events. Traders can use AHT to respond in real time to news stories that break outside standard trading hours, without having to wait for exchanges to re-open. Lots of important business developments – earnings releases, for example – are published when markets are closed. Economic data is also often released outside normal trading hours, and of course political events that will impact the markets can take place 24/7.

• Opportunity. Opportunistic trading outside standard trading hours can potentially bring big profits for those who follow the news closely and take advantage of price fluctuations after hours. Of course, there’s also the potential to make big losses if a trade goes wrong.

There are however, also a number of limitations associated with AHT:

• Price uncertainty. In the regular sessions, quotes are consolidated and represent the best available prices across trading venues. During after-hours trading hours, you may only see prices from one venue, which may not reflect the prices displayed in other electronic trading systems for the same security.

• Low liquidity. Since there tends to be a lower volume of shares available for trading after hours, there can be wide spreads between the bid price and the ask price.

• Price volatility. Lower liquidity can result in volatility being higher, with sharper price fluctuations than normally encountered during standard trading hours.

• Competition. Traders can face some tough competition in after hours trading, as they’re up against big institutional investors with massive resources and more information at their disposal.

AHT will often come into play when a stock price opens higher or lower than it closed the previous day. This might be because of a significant economic development or corporate announcement that’s happened outside trading hours.

Conclusion

After-hours trading allows traders to buy and sell securities after normal market hours have ended. This can provide a number of benefits for traders including more flexibility for those who have restrictive schedules during the day and the ability to react to finance and economic events that occur outside of regular trading market hours. 

However, there are also some limitations, as securities could face lower liquidity and higher volatility after-hours. Traders should always do their own research and never invest money they can’t afford to lose.

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