Explain After Hours Trading

Generally, individual investors purchase stocks when the stock market is open. Even if you place an order with your brokerage before or after trading hours, it waits until the market reopens to execute the order. If you have images of Gordon Gekko, however, you can loosen your tie, roll up your sleeves and trade stocks after hours like a professional investor. Beware, however, as after hours trading carries additional risk.


Back in the day, when you didn't have a smartphone or update your every move on Facebook, high rollers and mutual fund managers were trading stocks after hours, that is prior to the 9:30 a.m. eastern time opening and after the 4:00 p.m. eastern time closing of the country's two biggest stock markets, the New York Stock Exchange and the NASDAQ. As the U.S. Securities and Exchange Commission (SEC) notes, the advent of online communications, particularly the emergence of automated trading systems known as "Electronic Communications Networks," has allowed everyday Joes to trade like the pros--or at least die trying. After hours trading, in theory, is a straightforward proposition--you can buy and sell stocks before or after the market opens or closes.


The overarching key perk of participating in after hours trading is that you can react to stock market news, such as company earnings reports, as it happens. When a company reports earnings that beat analyst estimates after the market closes, you can take part in the possible rally that follows. You don't have to wait until the next day, when the market opens and the stock starts the day with the good news built in. This may sound simple, but simply put, it's not.


As the SEC points out, several things should make you wary, or at least cautious, of after hours trading. First, because fewer people take part in after hours trading--in other words, volume is generally light--stock prices move with more volatility after hours, and the spread between what people are willing to sell a stock for and what buyers are willing to buy a stock for is wider relative to normal market hours. These factors might make it more difficult for you to fill your order or get a desirable price. The SEC also contends that computer problems that hinder order execution can be more prevalent in after hours trading. In addition, your main competition in after hours sessions are often big-time investors who likely have access to much more trading information than you do.


As the Motley Fool warns, taking the above-mentioned risks into account, it's relatively easy to lose your shirt in after hours trading. It's not uncommon for an investor to react to after hours news and buy a stock on its upsurge. Euphoria, however, is often short-lived. The rest of the world sleeps on the news and the stock you paid a premium for reacts modestly when the market opens the next day. You paid $50 in after hours trading for a stock that ended up opening at $48 the day after it blew out its earnings. Not good.

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