“After-hours” trading and “late trading” both refer to investments made outside of normal business hours. While the two activities sound similar and often take place in similar time frames, the former is perfectly legal while the latter is not.
Pre-Market Trading and After-Hours Trading
Stock markets have normal business hours during which they are open for trading. In the United States, those hours are typically 9:30 a.m. to 4 p.m. Eastern Time (ET), Monday through Friday. The vast majority of trades take place during these hours. At one time, once the market closed for the day, only professional investors could place trades. Today, anyone can buy and sell stock during three distinct time periods, including two designated “extended-hours” windows during which the market is closed.
The first non-traditional trading period is known as “pre-market” trading. Pre-market trades take place in the morning, before the various stock exchanges actually open for business. Because investors trade through brokerage accounts, the specific times that they can trade may be limited by the rules associated with those brokerage accounts. TDAmeritrade (AMTD), for example, permits investors to engage in pre-market activity from 8 a.m. to 9:15 a.m. Fidelity permits trading as early as 7 a.m., while Vanguard does not permit it at all.
The second non-traditional trading period is the one most commonly referred to as “after-hours” trading. These trades take place after 4 p.m. ET, when U.S. stock markets are officially closed. Like pre-market trading, the hours during which after-hours trading is available vary based on the restrictions attached to a given brokerage account.
Why Investors Do It
Extended-hours trading provides a perfectly legal way to invest. It gives investors an opportunity to monitor stock prices based on earnings announcements, mergers and acquisitions, and other events that occur or are announced outside of normal trading hours. These events often cause stock prices to move, giving investors an incentive to buy and sell. Someday soon, investors will be able to trade 24 hours a day/7 days a week.
Risks and Challenges
On the other hand, just because you can trade after hours doesn’t mean that you should. After-hours trading can present a challenging environment for investors. Since trading occurs courtesy of a variety of electronic communication networks (ECNs), the rules, including security availability and trading hours, are set independently. Similarly, since the actual stock markets are closed during pre-market and after-hours trading, determining the fair “market” price of a given security can be a challenge. Most notably, the price on one ECN may not be the same as the price on another. Even getting the information you need to make an informed trade can be difficult. Beyond the mechanics of gathering information and placing a trade, the Securities and Exchange Commission warns investors about a host of potential hazards associated with after-hours trading. Some of the major challenges include those associated with:
Each ECN lists quote prices for stocks. Those quotes are often posted in isolation, meaning that they have no relationship to the quotes posted on other ECNs. The price you pay on a given ECN could be higher or lower than the price available on other networks.
Most trades take place during normal business hours when the stock exchanges are open. The volume of trades during pre-market and after-hours trading is significantly less, which can make it difficult to find willing buyers/sellers to execute trades.
The reduced volume of trading activity outside normal business hours can cause prices to be higher than what they might be if the markets were open and a larger number of buyers and sellers were seeking to make deals.
Price fluctuations during extended-market trading can be notably larger than those seen during normal business hours.
It is also worth noting that the traders making after-hours moves during non-traditional hours are often professional investors at big firms. Other investors may be at a disadvantage in both experience and access to information when compared to the professionals. Still, even for investors who choose not to trade during extended hours, simply monitoring the results of the after-hours and pre-market action can provide insight into trends and prices. This information often provides an indicator of the future direction investors will see markets/securities move when normal business hours resume. (The official SEC guidelines for after-hours trading can be found here.)
“Late trading” describes mutual fund transactions in which a buyer or seller places an order after 4 p.m. but is permitted to price the trade based on the closing price that was struck at 4 p.m. Such trades are illegal, because they give the buyer or seller an unfair advantage over other investors. The advantage results from the fact that mutual funds are priced just once a day. Unlike stocks, which change prices many times throughout the day, mutual fund prices are set once per day at 4 p.m. All trades placed prior to 4 p.m. get that day’s price. Trades placed after 4 p.m. are supposed to receive the next day’s price - but it doesn’t always happen that way. (See also "Why Late Trading is Illegal.")
In 2003, New York Attorney General Eliot Spitzer accused Nation’s Funds, owned by Bank of America (NYSE:BAC), of permitting hedge fund Canary Capital to engage in late trading as well as other unethical behavior. The scandal grew and ultimately engulfed more than a dozen companies, including Strong Capital Management, Putnam Investments, Alliance Capital Management, Goldman Sachs Group, Invesco, Janus, Morgan Stanley and more.
The Heart of the Crime
The essence of late trading is that it gives criminals an unfair information advantage. For example, consider an investor who purchased a given mutual fund at $10 per share. When the investor wants to sell these shares, he/she places a sell order. The amount the investor will receive per share is determined at the end of the day. The investor has no way to know for sure what that number will be prior to placing the order to sell. If the closing price is $9.99, the investor will lose money on the trade. If the closing price is $10.01, the investor will make a profit. Investors engaged in illegal late trading are told the closing price before they place their order to sell. If the price is $9.99, late traders would not place the trade. If it was $10.01, they would place the trade and lock in a guaranteed profit while taking absolutely no risk. Worse yet, because the trading costs are shared among all investors in a mutual fund, the illegal trade's cost is partially paid by the other investors who hold fund shares. The criminal makes a profit, while the legitimate investors take all the risk and help underwrite the costs of the illegal trade.
The Bottom Line
After-hours trading gives investors the opportunity to extend the length of their trading days. But for most long-term investors, normal business hours provide plenty of opportunity to trade and fewer potential pitfalls. If you are saving for retirement, a child’s education or other long-term goals, there is probably little need for you to engage in after-hours trading. Late trading is not something most investors will ever encounter during the course of their investment endeavors. It is an illegal activity that takes place between professional investors. Their bad behavior drives up costs for everybody else and generates bad publicity, which causes legitimate investors to question the ethics and intentions of major financial institutions and Wall Street in general.
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