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How does extended hours trading work?

Introduction

Most investors know that the major stock exchanges have standard trading hours -- the New York Stock Exchange and the Nasdaq Stock Market in the United States trade regularly from 9:30 a.m. to 4:00 p.m. Eastern time. We have all seen video of ceremonial "openings" and "closings" of the stock exchanges.

But investors can also buy and sell securities during "extended hours" trading, when the stock exchanges are closed. There are two windows:

  • Pre-market trading from 4:00 am to 9:30 am Eastern
  • After-hours trading from 4:00 pm to 9:00 pm Eastern
How is this possible? As explained in about U.S. stock exchanges, there are 30+ alternative trading systems ("ATS") in the U.S. that allow investors to buy and sell securities without going through an exchange. These systems actually account for about 40% of all U.S. trading activity. These systems are run by various private companies including the large investment banks like Goldman Sachs and JP Morgan. These systems are used to execute trades during extended hours.

It used to be that retail investors didn't have much access to the ATS and therefore didn't have much access to extended hours trading. However, ATS have become so prevalent that most online brokers now allow investors to buy and sell during extended hours.

Risks

Extended hours trading accounts for only about 1% of daily trading volume. You can find pre-market volume and after-hours volume charts on NASDAQ's website. Pre-market trading averages around 50 million shares traded per day, while after-hours trading averages around 100 million shares per day. That is a lot, of course, but remember that there are usually 15 billion shares traded every day (you can get volume data from the CBOE website).

During the day, when the exchanges are open, stock brokers use complex algorithms to determine how customer trades are executed. A given trade might be executed on an exchange, or on an ATS, based on various criteria. For extended hours trading, the broker uses a different algorithm to route trades, because exchanges are not available.

If the volume of activity is a lot lower, and the number of open "bids" and "asks" is small, you have to be a lot more careful when executing trades during extended hours trading. Always use limit orders. There is also a greater chance that an order will not be executed, because there aren't enough buyers and sellers operating at that time.

Monitoring activity

NASDAQ has two indexes that track extended hours trading: QMI, the NASDAQ-100 Pre Market Indicator, and QIV, the NASDAQ-100 After Hours Indicator. These indexes track changes to the NASDAQ-100 Index based on extended hours trading.

Stock index futures

Futures on the most important stock market indexes like the S&P 500 and the Nasdaq-100 are heavily traded. The CME, the CME Group, which is a publicly traded company, runs the world's exchanges for derivatives like options and futures. The CME Group happens to operate almost 24 hours a day, with the exception of Saturday. Trading hours for different products vary, but most futures are open for trading Sunday - Friday: 6:00 p.m. - 5:00 p.m. Eastern Time. Some products have a brief trading halt during the middle of the day for maintenance.

Many investors monitor the S&P500 futures trading as a gauge for how the market will open the next day.