As more and more investors jump into the market, more experienced investors are constantly looking for a new edge to find opportunities to make a profit. Something that has existed for a long time but isn’t talked about broadly is pre-market trading.
Pre-market trading can allow more advanced investors to find profits. But, like any other type of investing strategy, there are pros and cons. In this article, I will cover what pre-market trading is and the pros and cons so you can decide if it's a strategy worth implementing or not.
What Is Pre-Market Trading?
In the U.S., markets like the New York Stock Exchange are usually open for the regular trading session from 9.30 a.m. to 4 p.m. EST. But traders are still allowed to buy and sell securities on certain electronic exchanges before the normal trading hours. These electronic exchanges, also known as electronic communication networks (ECNs), don't have physical premises. Traders connect to them via a digital network.
One such ECN is NYSE Arca. It was built when the NYSE merged with one of the early ECNs. Instinet, another ECN, traces its origins to the late 1960s. One more significant feature of ECNs is that they allow pre-market trading during different hours. Some permit trading as early as 4 a.m. EST, though most of the pre-market trading in the U.S. happens from 8 a.m. to 9.30 a.m. EST.
Pre-market trading is quite a new development. The NYSE responded to round-the-clock trading in 1991 by allowing trading after the regular market hours. Computerized international trading has become increasingly common since then, and exchanges have extended trading beyond the normal market hours. Currently, extended hours trading in the U.S. markets can occur between 4 a.m. EST and 9.30 a.m., up until the opening bell signaling regular market hours.
Traders can also access the markets after the regular trading hours elapse. The after-hours trading session generally occurs from 4.30 p.m. EST to 6.30 p.m. EST. However, the after-hours trading can continue until the following day on the international exchanges.
What Happens When You Trade Pre-Market?
For those wondering who is allowed to trade pre-market, well, it's just about everyone. Although high net worth individual investors and institutions are technically the most common entities that trade before the market opens, just about anyone can do it.
Some investors monitor pre-market trading to determine where the individual securities and markets are heading before the regular session begins. Changes in trading volumes and prices can predict market events for the rest of the day.
Some traders will also use pre-market trading to get ahead of the market reactions to essential or breaking news. Political instability, overseas events, and other factors can easily affect the markets or individual securities.
For example, a company may release its earnings announcements just after the market closes. Suppose the earnings news is considerably different from the expectations. In that case, it could cause the stock to rise or fall on the next trading day. Pre-market traders may attempt to buy or sell the security early before the market can react to the news.
Examples of other events that might trigger pre-market interest include court rulings in a lawsuit or a drastic change in regulations. Moreover, when an influential analyst upgrades or downgrades a stock, it could encourage pre-market orders.
How Does Pre-Market Trading Affect the Opening Price?
Hours that immediately precede regular trading hours tend to include the release of various economic data from the federal government and news of revenue announcements from major companies.
Any investors who want to boost the momentum of the day could trade in the pre-market session and, in turn, affect stock prices during the regular market hours. The prevailing prices during pre-market trading hours will naturally affect most existing shareholders’ willingness to sell or buyers to offer at specific price points.
Trading volumes during the pre-market hours are usually much lower than those of regular trading hours. This is because there are many buyers and sellers in regular trading hours to facilitate stock trading.
As there are fewer participants before the open market hours, investors might find it harder to execute transactions. There is much less liquidity or the ability to convert securities into cash. Prices may not change as quickly as they do during the regular trading session.
Nevertheless, prices will still shift naturally as participants bid higher and higher prices (or lower), especially if there is an event or news about a particular company that could lead investors to buy or sell after trading hours.
Lower trading activity in the pre-market session also leads to higher spreads between bid and stock prices. As such, investors may have more difficulty executing their buy-or-sell orders or getting the price they want.
Pre-market stock prices will not always accurately reflect prices seen later in the regular trading hours. Therefore, there is a potential for discrepancies. Prices can also change dramatically on the typical closing day. Sometimes the closing price of a stock will be dramatically different from the opening price.
Also, since fewer sellers and buyers are active in the pre-market session, the stock prices tend to swing a lot more due to the low trading activity. The increased volatility could be seen when critical economic data is released. A corporation releasing its earnings before the market opens could also cause volatility.
The price shifts will generally be less dramatic when the regular market hours begin. However, investors are often influenced by the price difference in stocks compared to what they were selling for during the early morning hours.
In both post-market and pre-market sessions, investors should also expect to experience trading failures and delays. This happens when problems between their brokerage and the ECN are responsible for carrying out the trade. Network problems could prevent some trade orders from reaching the ECN as they should, including orders to cancel or change previously completed transactions.
Can Pre-Market Be an Indicator?
Index Futures are often used as pointers as to how the market will open. For example, when the Index Futures are up over 300 points for the Dow Jones, then it's an indication that the Dow 30 will likely open with a gap up. Nevertheless, it does not necessarily show how the rest of the trading day will go.
You can use Index Futures to tell whether it's a great day to sell at open, enter new trades, wait, or pull orders. Don't assume that if Futures are up (or down), the market can't move in the opposite direction.
For popular stocks, pre-market activity reveals whether professional traders are trading pre-market to establish different setups. They might do this to cause HFT (High-Frequency Trading) action or Dark Pools rotation, accumulation, or distribution hidden during the day. Or if the smaller funds are buying or selling a given stock. For individual stocks, pre-market activity also indicates the selling or buying by retail investors as the retail brokers are required to light these orders with the exchanges.
You could use the pre-market activity to your advantage. However, you first need to understand when the activity means buying and selling regarding the market participant groups. If not, you could find yourself in a big whipsaw while on the wrong side of the trade, especially during volatile market conditions.
How to Trade Pre-Market
Many brokers count pre-market trading capabilities as part of their offerings. However, different brokers will have different rules and availability for pre-market trading activity. As such, if you're interested in trading in the early hours, you should check your broker's fee schedule and policies for pre-market trading.
For example, while pre-market trading might start at 4 a.m., your broker might only let you trade from 6 a.m. to 9.30 a.m. How the pre-market trades are executed will also largely depend on the broker. Some brokerages, especially the larger ones, usually stick to regular commissions for pre-market trades though there are some exceptions.
As a rule of thumb, always read the fine print. Some brokers will have special surcharges or fees during these times. The charges could be applied per share, meaning they can add up. Your broker's specific policy should be easy to find on its website, or you can contact its customer service team.
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What Are the Benefits of Pre-Market Trading?
Pre-market price movements can have a significant effect on the prices in the regular trading hours. Even for those not planning to trade in the pre-market session, there are many advantages to checking these pre-market price movements.
Below is an example of how trading in the pre-market session can benefit you as a trader.
Say you spot massive stock movements in a particular industry. This could serve as a pointer toward a significant catalyst that might have a ripple effect when regular trading begins. You could then find momentum-inspiring news - things like mergers, earnings reports, or other critical business news - that could affect the overall market.
In this way, a move before the market opens could affect the overall stock picks. It can provide some great information about hot industries, sectors, and the economy's general direction in a more significant way. That's why it's essential to pay attention to the pre-market session, even if you don't have a desire to trade in it.
Related: How to Create a Trading Plan
Risks Involved in Pre-Market Trading
While pre-market trading allows traders to start trading as early as 4 a.m., there are fewer buyers and sellers during this time. Many are asleep, meaning even small orders have the potential to distort prices.
During the regular trading hours, buyers and sellers of most shares trade quickly, unlike in the pre-market session, where investors tend to experience less trading activity, making it difficult to execute some of these orders.
Less trading volume could also mean having to deal with bigger spreads. Therefore, many investors will find it hard to get as favorable prices as they would have during the standard trading session. Due to the limited trading activity, investors also have to deal with significant price fluctuations compared to the regular trading hours.
However, despite these risks, pre-market trading is starting to attract the keen interest of investors. It allows investors to respond immediately to important events and news, such as political turmoil in the United States and corporate misfortune, even before the market opens.
After Hours vs. Pre-Market
The difference between the two is just what it sounds pre-market trading occurs before the market opens (morning hours). At the same time, after-hours refers to the trading session in the hours following the regular market session’s closure (evening hours).
You want to find out from your broker exactly what hours they offer for after-hours and pre-market trading. Just as with pre-market trading, after-hours trading can be subject to a different fee schedule and some limits. So, as suggested by the SEC, read the disclosure documents before you proceed.
You might be wondering if one is safer than the other. Well, not necessarily. Trading outside the regular market hours carries just about the same risks.
Trading in the pre-market session may not suit new traders who want to dip into the world of stock trading, mainly for the risks involved. But if you know what you’re doing and are comfortable with these risks, then starting with a small position is a great way to test the waters.
Many traders like pre-market trading due to the higher volatility. But it’s essential to take your time to learn the ropes before you dive in. Don’t forget to check upcoming news releases and economic reports that might affect stock prices.