What is after-hours trading?
Looking for an after-hours trading definition? After-hours trading – 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 mean that direct trading can be done digitally – and even anonymously – without brokers.
Where have you heard about after-hours trading?
After-hours trading – or AHT for short – 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.
What you need to know about after-hours trading…
When you see someone ringing the opening or closing bell on the New York Stock Exchange, 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 4pm Eastern Time. 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.
But in recent years it's also 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 4:15p.m. to 8p.m.
- A morning session from around 8a.m. until 9.15a.m.
A little premarket trading is also done as early as 6 a.m. 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
So how did after hours trading become popular? Well, it was the development and spread of electronic communication networks (ECNs) that encouraged take-up of after-hours trading. 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, after-hours trading was mainly practised by institutional investors. Electronic communication networks allow these big institutional investors to interact anonymously and conceal their positions. But 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 New York Stock Exchange and Nasdaq.
Nasdaq 100 after-hours indicator
The growth of after-hours trading 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 4p.m. to 6:30p.m. ET. There’s also a Nasdaq-100 Pre-Market Indicator (PMI), which is an index of trading activity based on premarket open prices from 4a.m. to 9.30a.m. 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.
Advantages of after hours trading
After market trading has several advantages. Investors can use AHT to respond promptly 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 on the markets can take place 24/7. So AHT allows investors to trade on new information immediately.
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. But ultimately, after hours trading is just very convenient for people who simply don't have the time to trade during the day.
Risks of after hours trading
After market trading does have some drawbacks, including a lack of liquidity compared to normal day trading. You will probably see fewer trades and traders around out of hours, and solid or realistic pricing can be harder to find. Moreover, volatility tends to be higher in the AHT market, with sharper price fluctuations than you’ll normally encounter during standard trading hours.
Among other hurdles, you should recognise that individual investors 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. Another issue is that some brokers only allow investors to see quotes from their own trading system, and not from other ECNs. And of course, there’s the risk that computer delays could affect the execution of your trades.
Overnight trading
A couple more terms are worth noting – firstly overnight trading. This tends to be used in conjunction with the buying and selling of currencies between 9p.m. and 8 a.m. An overnight trading transaction is when an investor takes a buy or sell position at the end of the trading day in another market that’ll be open while his or her own is closed. Overnight trading is considered to be very risky because events could happen that affect the trader’s position before the market opens.
And what is late-day trading?
Finally, you might also have heard of late-day trading. Although it sounds very similar to after-hours trading, it’s actually something completely different and refers to a misconduct issue in the mutual fund industry.
Late-day trading is the illegal practice of fund managers accepting buy or sell orders after a mutual fund has calculated its net asset value (NAV) – usually at close of trading – and allowing the investor to pay the price based on the previous NAV. The practice has been likened to betting on a horse race after the race is over.
Late trading breaches US federal securities laws governing the price at which mutual fund shares are bought or redeemed, and it defrauds other investors in mutual funds by giving late traders an advantage that other investors don’t have. It is therefore considered to be highly unethical.
With after hours stock trading, on the other hand, classic market forces such as supply and demand determine changes in the prices of securities, so there’s no ethical issue at all.