The U.S. stock market's normal trading hours are from 9:30 a.m. to 4 p.m. Eastern Time, Monday through Friday. The after-hours market extends trading from 4 to 6:30 p.m. A similar pre-market opens at 8 a.m. and continues until 9:30 a.m. These latter two markets make up the overnight market. The two markets function quite differently, and certain characteristics of the overnight market have prompted the U.S. Securities and Exchange Commission to warn investors of the disadvantages and increased risk of overnight trading. Different studies of the returns from overnight trading vs. intraday trading, however, come to conflicting conclusions.
Where Intraday Trading Happens
Although you may retain a mental picture of a stock market where trading occurs on the floor of an exchange, this is no longer the norm. Most U.S. trades initiated during normal trading hours occur on nine major exchanges. But a trade originating in the United States may be executed on any of 71 exchanges.
Competition and Order Execution
Before electronic trading, intraday order executions were handled by specialists who matched buyers and sellers. Price spreads between buyers' bids and sellers' asks could be as much as $1 per share. The competition between exchanges, however, has reduced spreads on intraday trades substantially -- often to a small fraction of 1 cent per share. The proliferation of exchanges competing for business has also sped up order execution. Large orders are often executed in a fraction of a millisecond. In comparison with intraday trading in the 20th century, 21st century intraday trading is rapid, efficient and low-cost.
In many ways, trading in the overnight market is more like trading in the intraday market before 1990. An SEC paper enumerates the comparative limitations of overnight trading. Volume is greatly reduced. Spreads between bids and asks increase. Price information is not uniformly available to investors. Greater price volatility increases risk. Retail investors are disadvantaged in a market dominated by professional traders.
Conflicting Studies of Returns
Studies of the returns from overnight trading vs. intraday trading are inconsistent. One study of 20 years of returns for the 30 large corporations that make up the Dow Jones Industrial Average -- published by Seeking Alpha -- shows an 8 percent increase in the overnight market of kurtosis (a statistical measurement of the sharpness of price peaks and valleys), indicating relative volatility. This seems to validate the SEC's warnings of the increased risk of trading in the overnight market.
Economist Eric G. Falkenstein, in a separate study of returns over a 20-year period, concluded that trading in the overnight market produced substantially greater returns than intraday trading. Strikingly, he also concluded that most of the gains during the period were in the overnight market. When isolated, the intraday market returns were essentially flat.
In yet another study -- by University of Oklahoma finance and economic professor Scott C. Linn -- returns over a 25-year period were examined. Linn concluded that intraday volatility actually exceeded overnight volatility, directly contradicting both the SEC's warnings and widely held investor opinion. The dominance of professional traders in the overnight market could explain the greater returns in the overnight market in the second study, despite the greater volatility and other disadvantages noted by the SEC, but this is conjectural.
It is difficult to draw any reliable conclusions about overnight vs. intraday returns from these conflicting studies.
- U.S. Securities and Exchange Commission: After-Hours Trading: Understanding the Risks
- Seeking Alpha: Comparing Intraday vs. Overnight Return Distributions for Large Cap Shares
- Falkenblog: Another Overnight Return Puzzle
- American Finance Association: An Examination of Stock Market Return Volatility during Overnight and Intraday Periods, 1964-1989
Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.