Once upon a time, in the unimaginably-long-ago years of the 1960s, the only place to buy or sell stock was on the trading floor of a physical exchange. That first began to change in 1971, with the advent of Nasdaq’s electronic exchange, though many years would pass before the heavily-computerized trading environment we know today came into existence.
When buying and selling was executed by human traders who worked set hours, there was noopportunity to act on information that became available outside of market hours. (Even today, companies have a habit of releasing bad news “after the bell,” meaning after 4:00 p.m. Eastern time when the NYSE closes.) Technology has changed that, making available after-hours trading (AHT). A specific type of AHT is pre-market trading.
Pre-market trading takes place in the hour and a half before the NYSE opens, from 8:00 a.m. until 9:30 a.m. Eastern time. What occurs is important even for those who do not actively trade during that time, because the movement of specific issues and Dow, Nasdaq, and S&P 500 index futures is indicative of the direction trading is likely to take.
While it might seem as though pre-market trading offers an opportunity to get a jump on other investors, acting on news that came out overnight, the reality is more complicated. Liquidity of the market is limited, and other than geopolitical crises or overseas events that affect trans-national corporations, only so much new actionable information is generated overnight.
To address the first factor, because few investors participate in pre-market trading, the market is less liquid. That means finding a buyer or seller for a given issue can be difficult, and the virtually instantaneous trades to which investors are accustomed may not happen.
More significantly, lower volume and liquidity translate to wider bid-ask spreads, which is where market makers earn their money. The longer a market maker has to hold a block of shares, the more compensation he will demand in return, and the greater the spread. Particularly for short-term or intraday traders, that larger spread can erode or even destroy profits.
To address the second factor, since the financial industry is made up of people who have to sleep, relax, and otherwise spend time away from work, relatively little tradable information tends to be generated outside of normal business hours. Companies are not making announcements, analysts are not releasing opinions, and government agencies are not releasing reports or statistics.
Certainly a terrorist attack or natural disaster could occur anywhere in the world at any time, and companies and governments in foreign countries are acting and releasing their own information, but the trading opportunities presented tend to be infrequent or minor in most cases.
Moreover, there are some additional specific risks to pre-market trading. One is that limit and stop-limit orders do not work in after-hours trading, depriving the investor of valuable tools for managing trades. Another is that “panic selling” (and its counterpart, “euphoria buying”) tend to occur most during this time.
It is often better to sit out the trading that takes place outside regular market hours and assess the direction of a given stock or the market as a whole, developing a strategy to be executed once the market opens.
In short, the pre-market hours are better used in preparation for the regular trading session. Financial news sources like Bloomberg are very helpful, and will include relevant news that was generated in overseas markets during the night. News headlines and SEC filings can be indicators of upcoming major announcements, whether positive or negative, and you can use sites like SECFilings to be notified immediately of new filings by companies of interest.
Finally, if you are day trading, remember that it’s called day trading for a reason. All of your positions should be closed out at the end of the session. Strange things sometimes happen to the prices of securities overnight, and the last thing you want is to wake up and find that your trading parameters for a specific stock were obliterated while you slept.