After-hours trading is defined as the exchange of securities outside of an exchange's specified regular trading hours (usually 9:30 a.m. to 4 p.m. EST). After-hours trading occurs through an electronic communication network (ECN), which is essentially an interface that allows buyers and sellers to match up their buy and sell orders for a security.
The ECN enables these trades to go through even though the regular exchange through which the security trades has closed for the evening. In this article, we'll review how after-hours trading works and why after-hours traders frequently see a disparity between the bid and ask quotes.
- In the U.S., after-hours trading refers to trading that occurs on major exchanges outside the regular trading hours of 9:30 a.m. and 4 p.m. ET.
- After-hours trading starts at 4 p.m. and ends at 8 p.m.; pre-market trading occurs between 8 a.m. and 9:30 a.m. each trading day.
- Because there are fewer participants trading during after-hours, the trading volume can be significantly less than the regular trading day.
- This lower volume often leads to a wide separation in the bid and ask prices for a given security, which is referred to as the bid-ask spread.
How After-Hours Trading Works
In the United States, the regular trading hours for the major exchanges are between 9:30 a.m. and 4 p.m. ET each trading day. Before the 1990s, trading only occurred between these hours. However, once the use of computerized trading systems became prevalent, traders then had access to after-hours trading sessions, which start at 4 p.m. and end at 8 p.m. Pre-market trades occur between 8 a.m. and 9:30 a.m. each trading day.
Volume and After-Hours Trading
While there are many benefits of after-hours trading, one of its drawbacks is that it usually operates with significantly less volume than the traditional exchange-based trading day. Volume refers to the number of shares of a security traded during a specific time period.
It is because of the low volumes typically traded through after-hours trading systems that the after-hours bid and ask prices for specific securities can become widely separated. Traders refer to this price separation as the bid-ask spread.
Prices can fluctuate greatly during after-hours trading and it's possible for a stock's price to rise or sink rapidly only to move in the opposite direction once regular trading begins the next day.
The Bid-Ask Spread
The bid-ask spread may seem like a difficult concept to understand, but it is actually quite straightforward. Recall that securities are traded through exchanges by creating a match between buyers and sellers. For example, the price quote for a stock you see is really just the last price at which a trade was successfully completed. Also, recall that the bid for a security is the buy order with the highest price that has not yet been filled, and the ask for a security is the lowest-priced sell order that has not yet been filled.
In order to match the hordes of buy and sell orders, exchanges start with the highest bid (buy order) and try to match it up with the lowest ask (sell order). Because there are usually thousands of bid and ask orders in the system during the regular trading day, chances are usually very good that there will be little difference separating the highest bid order from the lowest ask order.
However, once the trading day finishes and after-hours trading commences, there are drastically fewer participants entering bid and ask orders into the system for a security. Because of this lack of order volume, there is a much greater chance that a big dollar value difference will exist between the quoted bid and ask values for a particular security.
The Bottom Line
If a stock has a wide difference between its after-hours bid and ask prices, this usually means there is little (if any) after-hours trading going on. In many cases, it does not imply there has been a big change in the security's market value. Some investors see after-hours trading as an opportunity to exit a losing trade or get in on a new trade before the regular trading day begins.
However, participating in after-hours trading does come with certain risks. Because there are fewer buyers, after-hours trading is less liquid. It's more volatile with wider bid-ask spreads. Stock prices can swing greatly during after-hours trading, particularly if a company makes an after-hours announcement such as an earnings report or a pending acquisition. Bigger, institutional investors who participate in after-hours trading have more resources, making it difficult for smaller investors to compete against them.