Late-day trading is the illegal buying and selling of mutual funds after regular market hours. This practice is wrongful and therefore distinct from after-hours trading of stocks because of one fundamental reason: in the after-hours market for stocks, the prices of securities fluctuate according to normal market forces such as demand, supply and new information. However, in the late-day trading of mutual funds, the price of the mutual fund (NAV) remains constant after a certain time of day because no one else is allowed to buy and sell it until the next day. This constant price is sometimes referred to as a stale quote because, late in the day, the price is no longer live and will not change.

So, if any material information affecting the fund becomes public after the fund's price is set, an opportunity is created for traders to capitalize on the stale quote price: traders exploiting this opportunity will buy the fund at the closed price knowing that the material information will affect the NAV, which will have changed at the opening of the market. This practice is unfair because it is done at a time when other investors are not participating in buying and selling the fund, so the late-day traders are exclusively trading at prices that are momentarily suspended and not reflecting the changes in the fund's "actual" worth - if other investors were allowed to trade the fund, the price would be affected by the market forces in real time and no one person would have an advantage.

For example, say a mutual fund company lets me late-day trade (illegally). After 3 p.m. today, that mutual fund's price remains constant at $5. Then, at 6 p.m. some positive material information on a company held by the mutual fund is publicized. I would then buy the mutual fund at the closed $5 price because I am guaranteed the price will increase once it is recalculated the next day. The investors who bought the fund before 3 p.m. today did not have this guarantee, and tomorrow's new investors of the fund will have to buy and sell the mutual fund at the new price, which will already be affected by the information. I, on the other hand, cheated because I bought the mutual fund at today's price but with the knowledge of what will happen tomorrow. Late-day trading is like making your bet after you've seen your opponent's cards - you already know what will happen once he or she lays down the hand.

  1. How often are mutual fund prices updated?

    A mutual fund's price, or its net asset value (NAV), is determined once a day after the markets close at 4 p.m. Eastern time ... Read Full Answer >>
  2. Can minors invest in mutual funds?

    A mutual fund can be opened under the name of a minor through a custodial account overseen by a guardian. The custodian holds ... Read Full Answer >>
  3. Can mutual funds only hold stocks?

    There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
  4. How do mutual funds compound interest?

    The magic of compound interest can be summed up as the concept of interest making interest. On the other hand, simple interest ... Read Full Answer >>
  5. Do mutual funds pay interest?

    Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
  6. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
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