Should after-hours trading be part of your stock market strategy?

Have you wondered what after-hours trading actually is and how it works, and what risks are involved? Here are some answers.

Have you ever turned on the news and heard reports on how a company is doing in after-hours trading after a big earnings announcement? Have you wondered what after-hours trading actually is and how it works, and what risks are involved? Here are some answers.

What is after hours trading?

Normal market hours are 9:30 a.m. to 4 p.m. ET. After-hours trading, as the name implies, is a trading session that occurs after the markets close in which investors can place orders to buy or sell stock. There is also a session prior to the market's open which is called the pre-market session. Together both sessions are referred to as extended-hours trading.

How to trade after hours

So how are trades executed when the major exchanges are closed? Extended hours trading is made possible by computerized order matching systems called Electronic Markets, which can be either Electronic Communications Networks (ECNs) or Electronic Stock Exchanges. An electronic market is simply a service that matches up buy and sell orders. For example, if you place an order to buy 200 shares at $45, the computer looks to see if there is an order to sell at least 200 shares at $45. If there is, the trade is done, if not, then the order will not be filled. At Schwab, clients can place orders for after-market trading and execution between 4:05 and 8 p.m. ET. Commissions and settlement times are the same as for the regular session.

There are, though, several differences between regular session trading and after-hours trading. For example, in the after-hours session, not all order types are accepted. Traders can only use limit orders to buy, sell or short. Stop and stop limit orders and orders with special conditions such as fill-or-kill, immediate-or-cancel or all-or-none can't be placed. Also, after-hours orders are only good for the particular session in which they are placed and do not carry over into any other session.

Learn about the pros & cons of after-hours trading

Advantages of after-hours trading

There are several advantages to after-hours trading.

Convenience: The after-hours session offers extended access to the market. Some traders simply aren't able to place trades during the normal session due to their schedules. The after-hours session allows them to check out the current quotes and potentially place a trade at a more convenient time.

Ability to react to news events: Many companies release earnings after the close of the regular session. After-hours traders can immediately place trades to manage their positions without having to wait until the next day's open. The example below shows IBM making a big move after hours after releasing their earnings report.

This same concept holds true for the pre-market session. Many economic reports, such as the significant monthly employment report, come out at 8:30 a.m. ET, well before the open of the regular session. Many companies report earnings before the opening bell as well. At Schwab, pre-market trades can be executed between 7 and 9:25 a.m. ET, allowing traders to react more quickly to these events.

Ability to act more quickly to technical signals: For traders who rely on technical analysis-based trading strategies, the after-hours session can be very beneficial. Many technically-oriented traders use closing price and volume figures to calculate trading signals. Once the signal is generated, the trader can place the trade immediately in the after-hours session without having to wait until the next morning when prices could be substantially different than where they were at the close of the regular session. The below is an example of an after-hours trade.

Risks of after-hours trading

While trading in the after-hours session can offer opportunities, there are also unique risks to be considered.

Non-consolidated quotes: In the regular session, the quotes you see are consolidated and represent the best available prices across all trading venues. In the after-hours, on the other hand, the quotes are not consolidated. You may only see prices from one venue and these may not reflect the prices displayed in other electronic trading systems for the same security.

Uncertain prices: The prices of some securities traded in the after-market may not reflect the prices of those securities at the close or open of the regular session.

Lower liquidity: Liquidity refers to the ability of traders to buy and sell securities easily without materially affecting prices. Generally, the more market participants there are and the more orders that are available, the greater the liquidity, allowing traders to get their orders executed quickly at competitive prices. Liquidity can be substantially lower in the after-market session. This can lead to delays in execution, partial fills or no fills at all. Also, some stocks may simply not trade after-hours.

Wider spreads: The spread is the difference between the bid (the highest price offered by all buyers) and the ask (the lowest price offered by all sellers). Because of generally lower liquidity, spreads tend to be wider in the after-market session than in the regular session.

Higher volatility: Volatility refers to the range of prices that occur in trading. Due to the lower liquidity and wider spreads in the after-market, volatility can be considerably higher than in the regular session. This could lead to inferior pricing on some trades.

Lack of calculation of index values: For traders dealing with certain index-based products, the lack of calculation or dissemination of index values in the after-market could put an individual investor at a disadvantage to those professionals who have access to proprietary systems which can quickly calculate index values based on individual stock prices.

The decision to trade after hours depends, of course, on your investment goals, trading style, and risk tolerance. While trading in the extended sessions is not for everybody, for those traders who understand both the potential risks and opportunities, it is certainly an avenue to explore.

Standard market vs. extended hours sessions

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