After-hours trades still risky, a decade later
Players are ‘fools’ and those looking to take their money, expert says
By Kate Gibson, MarketWatch Jun 9, 2011
NEW YORK (MarketWatch) — Nearly a dozen years after becoming an option for individuals, after-hours stock trading is risky for retail investors, as volume remains a sliver of overall trade and in fact has declined over time.
High volatility, less transparency, higher per-trade fees and increased competition from professionals are among the risks involved with trading U.S.-exchange listed stocks after the regular U.S. stock-market session from 4 p.m. until 8 p.m Eastern, and in a short window before the next session opens. Premarket stock trading occurs between 8 to 9:30 a.m. Eastern.
After-hours trading is “absolutely more risky, there’s no doubt,” according to Randy Frederick, director of trading and derivatives at Charles Schwab.
This trading arena is ringed by so many red flags that the Securities and Exchange Commission issued an investor alert on off-hours trading late last month, saying investors should be aware the rules can “differ significantly” than those governing regular trades.
For instance, the regulatory agency hasn’t instituted the same circuit-breakers on individual stocks trading after hours that it imposed for regular trading after last year’s “flash crash.”
In addition, the spreads — or differences between the bid and ask prices — have a tendency to be very wide, and many players are not visible, with retail players likely to be trading against large institutional investors, regulators, Frederick and other market observers said.
One of the top risks cited by regulators, such as low liquidity, has shown no sign of reversing. Off-hours volume as a percentage of overall trade has declined over the last several years, rather than expand as the market matured.
About 2% of volume in Nasdaq OMX Group Inc. and stocks listed on the NYSE Euronext’s New York Stock Exchange is generated off hours, with the volume of trades split between premarket and after-hours trading, said Wayne Lee, a spokesman for Nasdaq OMX.
That’s down from 3% of volume in June 2000, roughly a year after after-hours trading became available to nonprofessional traders, according to SEC estimates.
While the SEC and Nasdaq declined to speculate on why volumes have fallen, one reason may be that we now operate in a global market.
Index futures, as opposed to the individual stocks that move over the stock-exchange platforms after hours, give investors an avenue to react to corporate, economic or geopolitical news practically around the clock.
Stock-index futures including S&P 500 Index futures, Nasdaq 100 futures and Russell Index futures “trade almost 24 hours a day,” said Elliot Spar, market strategist at Stifel, Nicolaus & Co.
Still, overnight and early-morning trading in index futures can suffer from some of the same constraints as off-hours stock trading. Liquidity is often thin and traders cannot lay off risk in the underlying basket of stocks. “In other words, many of the moves in after-hours trading are exaggerated,” added Spar.
Once restricted to high net-worth investors or institutional investors such as mutual funds, off-hours stock trading came into play for the retail investor in mid-1999, viewed as a way for investors to react to stock news, such as earnings reports, coming after the regular market has closed or before it opens.
Broker-dealers began offering retail customers a means of directing orders to Electronic Communication Networks, or ECNs, to be eligible for execution after the close of the regular-trading session. The bulk of trading in the session occurs directly following the closes at 4 p.m. Eastern.
“Company news is the main driver behind after-hours trading. It’s more of a news play on an acquisition or earnings,” said Stephen Ehrlich, the chief executive at broker Lightspeed Financial LLC.
“Liquidity is not as deep, but there is still opportunity,” he added, noting that as much as 5% of Lightspeed’s volume gets executed in the after-hours market.
Keith Springer, president of Springer Financial Advisors, has made after-hours trades “for clients who call me after the close and need to raise money, or when I’ve speculated on one of the big company earnings, or when I needed to make a trade and I forgot.”
But, after-hours trading “is harder to do than you might think; there are not that many shares available and they don’t have to make an orderly market,” Springer cautioned.
Executing an order after hours is often not feasible, given there may not be market makers active in many or all stocks. “In fact, some stocks may not trade at all during after-hours trading,” advised regulators from the SEC’s Office of Investor Education and Advocacy.
What’s more, not all of the SEC’s market rules apply to after-hours trades, including the circuit-breaker program expanded by the regulatory agency in September after the so-called May 6, 2010 “flash crash” that had the Dow Jones Industrial Average plunging nearly 1,000 points before recouping the bulk of that loss by the close.
The market rules mandating a trading “pause” in a stock if its price moves up or down by 10% or more in a five-minute period would be hard to extend after hours, given the difficulty of devising workable, meaningful levels for trading where low liquidity often translates into high volatility.
During regular trading, buyers and sellers of most stocks actively compete on prices, making it relatively easy to quickly buy or sell with little effect on prices. But after hours, “the bid-ask spread is so wide you can drive a truck through it,” remarked Jim Angel, a professor of finance at Georgetown University.
Take one recent premarket-trading session: On May 26, shares of equipment maker CNH Global N.V. rose 9.1% before the opening bell after a brokerage upgrade. In the regular session, the stock added a more modest 4%.
In that same session, Arca Biopharma Inc. surged 8.8% ahead of the open after it said it would expand a trial of its cardiovascular-drug candidate to include patients with atrial fibrillation. It then gained only 2.2% during the day.
Likewise, Semtech Corp. jumped 8% in the premarket a day after the semiconductor maker reported first-quarter results that topped expectations, with its shares then gaining 3.6% during the regular session.
Cuban a player
Investors who opt to trade after hours should always use a limit order, which can only be executed at the limit price or better, to protect themselves from unexpectedly poor prices, recommended Springer, given the potentially wide spread between the bid and ask prices.
One high-profile example of what can occur after hours involves billionaire and Dallas Mavericks owner Mark Cuban.
In the still-pending case, the SEC alleges Cuban violated insider-trading rules by selling his stake in Mamma.com after learning of the Canadian search engine’s plan to sell a stake to private investors — a move regulators say Cuban viewed as one that would dilute its 6.3% stake.
“Well now I’m screwed. I can’t sell,” Cuban was quoted in the SEC suit as telling Mamma.com Chief Executive Guy Faure at the end of a June 28, 2004, phone call.
During after-hours trading the same day, Cuban sold 10,000 of his 600,000 Mamma.com shares, selling the remainder during regular trading the next day in moves that the SEC contends helped the tycoon avoid more than $750,000 in losses.
A federal appeals court in Texas in September sent back for trial the case against Cuban, who has filed a countersuit, alleging that the SEC brought the case against him in bad faith.
Moves by a large investor in a stock, at a time of day when there are few buyers and sellers around to compete on prices, can add to volatility in the off-hours market. For some financial advisers and experts, it’s just too dicey for the small-time investor.
After-hours trading largely involves “fools or people trying to make money off those fools,” said Georgetown’s Angel, who likens the action to taking a stroll through Manhattan’s largest pubic park in the middle of the night. “Who are you going to find in Central Park at 3 a.m. but a bunch of drunks and predators looking to roll them?”
Angel added most retail investors should heed the following advice: “Stay away.”