How can investors benefit from after-hours trading?

Posted on Thursday, July 25th, 2019 MarketBeat Staff

Summary - The stock market never really sleeps. Of course, investors know that the market is active during the trading day which is from 9:30 a.m. – 4:00 p.m. EST. However, one of the many gifts that the Internet has provided investors is the arrival of electronic communication networks (ECNs) that make it possible for online investors to trade stocks and other securities after hours. After-hours trading is an investment strategy that comes with some restrictions, but also can be a beneficial strategy. After-hours trading is restricted both in terms of the maximum allowable size of a single trade (currently 25,000 shares) and also the type of trade that is available (a limit order). After-hours trading is also typically defined by lighter volume and wider bid-ask spreads which make it a riskier form of investing. However, for the informed trader who has a higher risk tolerance, there is the potential to buy or sell a stock based on news announcements that break after the markets close for the day. This type of trading activity is common during earnings season when companies habitually wait until after the stock market has closed to release their earnings report.

Introduction

With the advent of electronic communication networks (ECNs), it has become possible for retail investors to buy and sell equities after the U.S. stock market exchanges (e.g. New York Stock Exchange, NASDAQ) close for the day. What is known as after-hours trading allows traders to capitalize on positive or negative news about a stock that may come in after the markets have closed. In this article, we’ll define what after-hours trading is and when it occurs. We'll also explain the advantages and disadvantages of this investment strategy. We’ll also explain pre-market trading which is another form of extended-hours trading that occurs when the U.S. exchanges are closed.

What is after-hours trading?

After-hours trading is buying and selling of stocks that takes place after normal trading hours. Trading occurs through an electronic market between 4:05 p.m. and 8:00 p.m. After-hours trading (also called after-market trading) is now available from many online brokerage firms including Charles Schwab, Fidelity, and TD Ameritrade. In some cases, brokerage firms may charge more for the convenience of executing these trades. Investors should make sure to they are aware of the expenses involved with this form of trading. Whereas trading during standard market hours is brokered through a variety of venues including market makers and ECNs, only ECNs are used for after-hours trading.

How can investors benefit from after-hours trading?

Many companies will report their quarterly earnings after the market closes. If the earnings report exceeds analysts’ expectations investors can take this opportunity to bid the stock price higher. It’s not uncommon for company shares to climb dramatically in after-hours trading. A recent example of this was Microsoft which saw a significant increase in their stock price after an earnings report showed stronger than expected growth in their cloud computing segment.

Of course, the opposite is also true. If a company reports negative earnings, after-hours trading is an opportunity for traders to sell the stock. In July 2019, Netflix reported second-quarter earnings after the closing bell on the U.S. stock exchanges. While the company's overall financials were mostly in-line with analysts' expectations, the company reported a significantly lower increase in new subscribers than they had forecast and also an increase in subscribers who had canceled their service. The stock declined sharply in after-hours trading. Investors who waited until the next day to sell the stock were already seeing a nearly 20 percent decline in the stock.

What are the disadvantages of after-hours trading?

One of the main disadvantages to after-hours trading is that there is typically significantly lower volume during these sessions (25,000 shares is the maximum amount allowed for a single order). Lower volume (and low volatility) will tend to make the bid-ask spread larger which means many trades are simply not executable. Also, some stocks do not trade after hours. Trades that cannot be executed by the end of after-hours trading will be canceled. This is different from a limit order that is placed during regular market hours which will fall into a queue for the next trading day.

Another disadvantage to after-hours trading is that unlike investing during normal trading hours in which many different order types are available, only limit orders are possible during after-hours trading. A limit order sets a maximum or minimum price at which a trader agrees to buy or sell. This is different from a market order which is designed to be executed immediately at the current market price. On the one hand, this makes sense because an advantage to limit orders is that limit orders can provide the most benefit at times when a stock is being lightly traded and/or has a wide bid-ask spread. On the other hand, as noted above, many after-hours trades cannot be executed because the price never reaches the parameters of the limit order. This is because for a “buy” limit order to be filled both the ask and the bid price must fall to the specified price.

Another disadvantage for some individual investors is that many institutional investors use after-hours trading as a way for institutional investors to make trades anonymously, concealing their actions from individual investors.

Other forms of extended trading hours

Another form of extended trading hours is pre-market trading. Pre-market trading occurs in the pre-market hours from 7:30-9:30 a.m. on days when the market is trading. This trading has the same advantages and disadvantages as after-hours trading. An additional benefit for investors to pre-market trading is the ability to capitalize on stock price movement in the international markets which occurs after the close of after-hours trading on the U.S. market.

The bottom line on after-hours trading

After-hours trading can be an effective trading strategy for investors who are willing to accept a little more risk for the chance to react to breaking news about a stock that may affect the stock price positively or negatively. For example during earnings season, many companies have gotten into the habit of reporting their earnings after hours. If their report comes in below analysts’ expectations, reporting after hours can limit the damage to their stock price because the volume during after-hours trading is lower. The lack of volume can also be a negative for the individual investor since after-hours trading is restricted to limit orders. Additionally, the bid-ask spreads may be wider due to the lower volume. Another potential negative for the retail investor is that they are typically bidding against institutional investors during this period.

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