What is After-Hours Trading? Learn the Benefits too

Stock exchanges worldwide operate for fixed hours per the local time zones and trade practices. Trading hours refer to predetermined hours during which market participants actively trade in securities. For instance, the Bombay Stock Exchange operates from 9:15 a.m. to 3:30 p.m. from Monday to Friday.

Investors may even trade in multiple Stock market that function in different time zones. This article explains the meaning of after-hours trading.

After-hours trading

After-hours trading is the purchase and sale of securities outside the regular market hours of the exchange. Investors especially turn to after-hours trading in case of a significant event or news announcements once the market closes. Prices may fluctuate considerably on the news of a change in top management, political turmoil, regulatory compliance, etc. After-hours trading allows an investors to react to such announcements instantly.

Suppose you hold 100 shares of HDFC Bank Limited, and it releases quarterly earnings reports after market hours. The company's performance is below expectation, and the price may fall. You wish to sell the shares immediately and limit losses with after-hours trading.

NASDAQ and New York Stock Exchange permit after-hours trading between 4 p.m. and 8. p.m. on weekdays where you can take a call on these shares.

How does after-hours trading work?

Unlike regular exchange transactions, after-hours trading uses an electronic communication network (ECN) to place orders. ECN uses limit orders to match the corresponding buy or sell orders on the network. Thus, investors can only place limit orders valid only for after-hour trading. If the order fails to execute, the investor will have to put a fresh order when trading resumes on the next day.

To execute an after-hours order, log in to your brokerage account, select the stock you want to trade, and place a limit order. Your broker may charge extra fees for after-hours trading. The settlement of after-hours transactions is the same as that of regular trading.

Volume and Pricing

Typically, the volume of after-hours trading is significantly lower than regular trading. It may spike with some news or related event announcement and taper as the session progresses. Consequently, after-hours trading in illiquid securities involves significant risk. Due to lower volumes, the after-hour trading spread tends to be high. Spread refers to the difference between the bid and ask prices.

With low volumes and steep pricing, after-hours trading volatility is high. It is relatively straightforward to inflate or deflate prices since fewer shares may substantially impact the share price.

Benefits of after-hours trading

After-hours trading offers multiple benefits. These include:

• Ease of convenience – After-hours trading allows investors market access for longer hours. Investors have the opportunity to immediately act upon major events or announcements even after the market closes. Secondly, non-professional traders can trade outside office hours and juggle office work with investment goals.
• Pricing Opportunities – Investors have a pricing advantage, despite the volatility involved with after-hours trading. It proves to be a significant advantage if the stock price moves temporarily to a practical level during after-hours.
• Fresh Information – After-hours trading allows investors to evaluate new, in-depth information released after a trading day. The information may have a short-lived effect, but investors can act upon it before the next trading day.

Risks of after-hours trading

Having understood the meaning of after-hours trading, let's evaluate the risks involved. Regular trading on an exchange is subject to inherent risks and limitations. After-hours trading is subject to additional consequences that include –

• Pricing Risk – Financial institutions use multiple ECNs for after-hours trading, whereas retail investors have access to only one ECN through the broker. The price discovery mechanism is restricted. An investor has access to multiple avenues during a regular trading session, but after-hours trading limits participation to one network.
• Liquidity Risk – The number of participants across ECN is limited for after-hours trading. Thus, there is little liquidity across stock, and the bid-ask spread is higher. The risk of non-execution of an order placed is high.
• Volatility – The volatility during after-hours trading tends to be higher. In case of a significant event or news announcement, the stock will trade extensively as the market evaluates the news and discovers the stock price. For investors, it is challenging to gauge the validity of the after-hours trading price.
• Market Manipulation – The risk of market manipulation is manifold for after-hours trading. Since the trading volumes are low, an individual investor requires a modest quantity of shares to move the market in any direction. Contrary to popular belief, after-hours trading prices are not an accurate indicator of the trading price for the next market session.

Participants in After Hours Trading

Initially, large financial institutions and ultra-high net worth individuals had access to after-hours trading. Retail investors were not comfortable with such unconventional trading methods. Until the introduction of ECNs, only prominent players participated in after-hours trading, so the volumes were significantly low.

However, ECN provided an opportunity for retail investors to trade beyond regular stock market trading hours. With increased retail participation, the liquidity in after-hours trading also increased. Various brokers offer after-hours trading services to investors.

Bottom Line

While after-hours trading provides extended market access, it entails significant risks. Investors must be completely aware of its pros and cons before investing. In India, after-hours trading is in a nascent stage and executed in unorganized, over-the-counter markets.