What is overnight?

Looking for an overnight definition? In the most simple terms, it is the buying and selling of currencies between 9.00pm and 8.00am local time. Overnight trading usually happens when an investor decides to take a position at the close of a trading day, in an overseas market that will remain open while the local market is closed. The trade is done at some point that evening or the following morning.

Where have you heard of overnight?

All major stock exchanges have set and regulated trading hours, and these are the portions of time when regular trading takes place. Most US exchanges trade from 9.30am to 4.00pm (local standard time) with the opening price being created by the first trade and the closing price being made from the last one. However, in actuality, shares can be traded on three different markets – the premarket, the regular market and the after hours market.

Different exchange trading times are in operation in other countries. The London Stock Exchange trades from 8.00am to 4.30pm every day except Saturdays, Sundays and holidays. The Frankfurt Stock Exchange, Euronext Paris and the Swiss Exchange are open from 9.00am to 5.30pm, while Milan closes 5 minutes later. In Asia, the Tokyo Stock Exchange trades from 9.00am to 3.00pm with an hour’s lunch break; and Shanghai is open from 9.30am to 3.00pm, with 90 minutes for lunch.

Overnight trading typically reflects trades made on a foreign market whilst these exchanges are closed. For example, the forex market runs for 24 hours a day, in exchanges worldwide. The Asian, European, North American and Australian overlap in trading hours makes overnight trading possible. With this in mind, investors must remember the high levels of risk involved with overnight trading, which include overnight delivery risk and foreign exchange risk.

What do you need to know about overnight...

The overnight market
The overnight market is the portion of the money market involving the shortest term loan. With after market trading, lenders and borrowers agree that the funds are only to be held overnight, so the money must be repayed by the next day, with the interest included. As the loan is only borrowed for a short period of time, the interest rates are generally the lowest rates at which banks lend money – this is known as the overnight rate.

Most of the movement that takes place happens in the morning, as soon as the business day has started. This is thought to be the case because clients of financial institutions need a large amount of money at the start of the day, sometimes more than the institution has on hand, so they borrow from the overnight market on that particular day. Conversely, if the institution has an extra surplus of money, they could choose to lend on the overnight market when appropriate. Banks form the largest participatory bulk of the overnight market, although other large institutions like mutual funds make up a large amount too.

Overnight rate
The overnight rate is typically the interest rate that major banks use to lend and borrow from one another in the overnight market. In certain countries, for example the United States, this can be the rate that is directed by the central bank to sway monetary policy. In the majority of countries, the central bank will also take part in the overnight market and will borrow or lend money to other large banks.

The overnight rate exists because during the course of a day banks will exchange money with each other, with major clients, with foreign banks, with client representing parties and with their own account. At the close of a financial working day, a bank may have an excess or a shortage of funds. Banks that have extra funds or excess reserves deposit or lend them to other banks, who usually borrow from them. The overnight rate is the interest rate paid to the lender by the borrower. Banks can also lend or borrow for extended periods of time, depending on their needs and their opportunities. Most overnight banks will give their overnight rate on a monthly basis. Overnight rates are viewed as a measure of the prevalence of the liquidity in the economy. In conditions of narrow liquidity, overnight rates raise dramatically. They also rise when there is a lack of confidence in banks, as witnessed in the 2008 liquidity crunch.

Overnight indexed swap
The overnight indexed swap (also known as OIS) is an interest rate swap where the periodic floating payment is generally placed on a return determined from a day-to-day compound interest investment. The reference for this rate is the overnight rate and the type of formula used depends on this rate. The index rate is the most common rate for unsecured lending between different banks, for example Sonia for sterling and the Federal Funds Rate for the U.S. OIS is commonly thought of as a less risky interest rate in comparison to LIBOR as it's fixed interest and there is less counter-party risk.

The LIBOR-OIS spread is difference in the LIBOR and OIS rates. The difference in the spread between these two rates is seen as a quota of health in the banking structure. It's also considered to be a strong gauge for the relative stress in the money markets as well as a critical measure of risk and liquidity there. A high LIBOR (a higher spread) is mainly understood to be an indicator that major banks are less willing to lend money and a lower spread demonstrates a higher amount of liquidity in the market. Therefore, this spread can be viewed as an expression of a banks' perception of the creditworthiness of other banks and institutions.

Stop loss
This is a type of order that's allocated to a broker to sell the security in question when it reaches a certain price. A stop loss order is structured to restrict the loss of a position made by an investor on various types of security. This sort of order is usually linked with a long position, but it can also be associated with a short position if the security trades above a set price. A stop loss order can protect a trade if the investor cannot watch it – for example, if it's an overnight trade. The execution of the trade however is not guaranteed especially in circumstances where trading in the stock gaps up or down in price or is halted.

A stop loss order is a quick and easy tool that is severely overlooked by many investors. This type of order can strap in profits and can restrict excessive losses and with various styles of investing, almost all can benefit from this trade. Many view stop loss orders as a sort of insurance policy.

Where can you find out more...

Our glossary has a fantastic amount of information on all things stock market related. Would you like to find out more about growth investing? Or maybe you want to inform yourself a little more on the in's and out's of liquidity risk. If you are interested in finding out more about all things overnight trade related, take a look at Joe Duarte's book After Hours Trading Made Easy: Master the Risk and Reward of Extended Hours Trading.