Night Trading: A New Look at a Market of Opportunity (Part 1)
Once the red headed step child of the otherwise viable US equity markets, the after-hours and pre-market sessions (commonly referred to as the extended-hours) have grown up a bit since many investors last paid them any mind. Like children, markets grow, mature and often marry, creating larger and more viable entities. In the case of equity markets, larger translates into more liquidity which is the both the life blood and metric of growth for any capital market. The rapid consolidation of the electronic markets (ECNs) has helped fuel a marked increase in participation and trading by both institutions and individuals outside of the regular session. Serious investors take note.
A Brief History
Extended-hours trading has traditionally been referred to as any trading activity that occurs outside of the 9:30 am to 4:00 PM regular session. From 1975 to 1999, after-hours trading in the U.S. was restricted to professionals and institutions. Much of trading at this time was supported by Instinet, an institutional brokerage with an electronic share matching platform with the same name. It wasn’t until the SEC lifted some regulatory hurdles in mid 1999 that the individual investor (retail) was granted access to trading in the extended-hours via the online brokerage platform.
In the late 90’s, the introduction and proliferation of the electronic communication network (ECN) technology ushered in a new era of the competitive and ultra fast trading venue. These low-cost electronic markets were widely adopted by the entire trading community and most notably the retail brokers via the online platform. Like the eBay of stocks, ECNs were then and are still today the primary order destinations and sources of liquidity in the after-hours and pre-market sessions.
After much consolidation, the two primary markets or ECNs in the extended-hours today are INET (the combination of Island and Instinet) and NYSE Arca. Individual investors can trade in the pre-open session from 4 – 9:30 am and after-hours from 4 – 8 PM EST (access varies by broker).
A Target Rich Environment
The after-hours and pre-market is without question a news driven environment. In other words, the vast majority of trading activity in any given security outside of the regular session is directly related to some corporate announcement or some other newly public information. The primary event driver tends to be earnings, but there are many other commonly occurring events such as analyst rating changes and M&A announcements which tend to spark significant trading activity. For those that are well versed in the off-hours trading markets and for those who have real-time access to after-hours market news services, many of these events present attractive trading opportunities.
Short and long-term trading opportunities develop after-hours due in large part to the presence of liquidity traders who are eager to get in or out of any given position quickly. Extended-hours trading is dominated by liquidity traders (generally large institutions) who are willing to incur substantial transactions costs to reduce or increase inventory and exposure which they presumably could not do before the end of the regular day session.
Because these participants tend to be buying or selling for reasons unrelated to any new information released outside of the normal trading day, they often provide the much needed contra party liquidity to position traders looking for event driven trading opportunities after the close and ahead of the opening bell. These large participants may be buying or selling an issue for reasons unrelated to recent news such as customer redemptions or portfolio reallocation. Also present are active hedge funds and individuals looking to take advantage of short term trading opportunities.
The Risk of Oversight
What used to be described as the “wild west of trading” or “a bit like skydiving,” has evolved into something much less hair-raising. The consolidation of several leading electronic markets in recent years has resulted in a much more tradable, less volatile and liquid market environment. With all major online brokers providing their customers with access to the extended-hours, more and more investors are taking advantage of these markets and the opportunities they often present.
At a minimum, find a trading platform and/or online data source which can provide the extended-hours information tools necessary to stay informed. This tool set should include real-time after-hours news and quotes. More active traders may also benefit from historical after-hours analytical services which can provide a predictive guide as to how any given stock has reacted to similar news in the past.
Regardless of whether or not you actually trade outside of the regular session, it’s critically important to recognize the significance of overnight news and resulting trading activity. The majority of the most significant regularly scheduled announcements in a public company’s fiscal cycle are released during an extended-hours session. Earnings announcements, for example, are typically released after-hours and are often a trend changing or confirming events. Some of the largest publicly traded companies can move in double digit percentages on significant volume from the regular close one day to the open the next.
Whether you’re tuning in for opportunity identification or portfolio preservation, the clues offered by staying abreast of extended-hours activity shouldn’t be ignored. Without further delay, let’s take a look at one of the many event-related trading opportunities associated with pre-open trading. Future articles in this series will shed some light on other event-related strategies and activity.
Brooks McFeely is widely regarded as the leading expert on extended-hours trading. He is a Managing Partner for Brochet Capital Partners, LP and the founder of Midnight Trader, Inc. (www.midnighttrader.com), the leading provider of pre-market and after-hours trading analysis and news to retail and institutional investors.