Trading on the after hours market can easily do more harm than good to your portfolio returns.
One of our Inner Circle members once asked us about trading on the “after-hours market,” and specifically how a stock can rise (or fall) by a large amount overnight when the major stock exchanges are closed.
Most stock trading takes place during the regular business hours of major stock exchanges. For the Toronto and New York exchanges, that means between the hours of 9:30 a.m. and 4:00 p.m.
However, for many years, trading was available to institutional investors before and after regular exchange hours.
The popularity of online investing during the 1990s bull market led to a demand by individuals for access to similar after hours market trading.
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In 2000, Canadian brokerage firms began making after-hours market trades on U.S. exchanges available to individual retail investors in Canada.
To trade on the after-hours market, a retail investor must participate in online stock investing, and must become a customer of an Internet brokerage firm that has its own electronic-trading platform, called an electronic communications network, or ECN. Alternatively, the brokerage firm must have access to an ECN. Instinet is an example of a major ECN.
Some ECNs are regulated exchanges. Others are side businesses of broker-dealers. Still others are unregulated.
Unique risks of after-hours market trading
After hours market trading differs from trading during regular hours in many ways. For one, there are far fewer buyers and sellers after hours, so there may be less trading volume on the stock you’re interested in. This may result in wide spreads between bid and ask prices, which makes it harder for you to buy at a favourable price. Thin trading also means that you’re likely to see more significant price fluctuations than during normal hours.
Moreover, even though access to after-hours trading has improved, this area of investing is still dominated by large institutional investors who have access to plenty of resources, so you’ll be up against some powerful competition.
From time to time, it might seem to be an advantage to have access to after-hours trading, but other times it will cost you money. Generally speaking, we think you are better off doing your trading during normal hours.
Trading tips for every investor
Whether you’re trading on the after hours market, or during normal trading times there are a few things every investor can do to be more profitable.
The first thing all investors should be mindful of is trading too frequently. The main risk is that the lower costs and higher speeds of online stock investing can quickly lead otherwise conservative investors to trade too frequently. That can lead you to sell your best picks when they are just getting started.
Trading online on the after hours market may even prompt some conservative investors to take up short-term trading. That’s just another danger of after hours market trading, because there’s a large random element in short-term stock-price fluctuations that you just can’t get away from, plus the inherent dangers of volume trading.
Automated stock-picking systems can backfire
Some investors who trade stocks online use automated stock-picking systems to help them make investment decisions. These systems are typically marketed with impressive-looking performance records designed to make investors think they have strong track records.
However, those records are typically derived by “back-testing” the program against past data. In other words, the promoters go back through old trading records and see what would have worked in the past.
Automated stock-picking systems essentially do two things: First, they narrow down the data you use when you make investment decisions. Second, they apply a fixed rule, or rules, to draw a conclusion or an investment decision from that selection of data.
The trouble is that the market’s key concerns continually change. Today’s good investments can turn into tomorrow’s dead ends.
For a time, these systems seem to work, but that’s usually coincidental. If the market is going up and they tell you to buy volatile investments, then they automatically generate profitable trades. Then they quit working, and begin pumping out unprofitable trades. Often this happens just when they can do the most damage to their users.
Selling too early
The biggest temptation investors need to resist when they have access to an after hours market is quell the urge to dump a high-quality investment just because you think a falling market may drag it down. After all, the market generally begins rising again, just when things seem to be at their bleakest.
Our rule is that you can cut way down on times when you really need to sell by consistently buying well-established, high-quality stocks. These stocks can still drop sharply when the economy falters or bad news strikes, of course. But these are the stocks that snap back quickest and most reliably when the trend reverses and bad news comes less often. That’s why it generally pays to hold on to stocks like these through market setbacks. But you need to look at each case individually, since there are exceptions.
Have you traded many stocks on the after hours market? Has access to the after hours market been profitable for you? Share your experiences with us.