How does after-hours trading work?
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After the major U.S. stock exchanges close at 4 p.m. Eastern Time, after-hours trading begins. The after-hours trading activity can last until 8 p.m., though volume usually drops down considerably earlier. Electronic communication networks (ECNs) are used to conduct after-hours trading. Click here to learn more about goat farming.
If information is released after the stock exchange closes, dealers and investors can use after-hours trading. In some situations, such as when an earnings report is released, the news may motivate an investor to purchase or sell a stock.
The volume for a stock may jump when the news is first released, but it usually thins out as the session progresses. By 6 p.m., the amount of volume has often decreased dramatically. Trading in illiquid stocks after hours carries a significant risk.
Not only is volume sometimes more expensive in after-hours trading sessions, but so is price. It is not uncommon for spreads to be wide after-hours. The spread is defined as the difference between the bid and ask prices. Because there are fewer shares trading, the spread may be much wider than during a normal trading session.
If the lack of liquidity and prices weren’t reason enough to avoid after-hours trading, the lack of participants makes it even riskier. In some cases, regardless of the news or event, certain investors or institutions may choose simply not to participate in after-hours trading.
Also Read: A Short Guide to Stock Options Trading
The earnings results of Nvidia Corp. (NVDA) in February 2019 are an excellent example of how after-hours trading works and the risks that it entails. On February 14, Nvidia released its quarterly results. The stock rose to nearly $169 from $154.50 in the 10 minutes following the announcement.
As shown in the chart, volume was steady for the first 10 minutes and then dropped sharply after 4:30 p.m. Around 700,000 shares traded in the first 5 minutes of trading, and the stock rose nearly 6%. Volume, on the other hand, slowed significantly, with only 350,000 shares trading between 4:25 and 4:30. The volume of trading had slowed to 100,000 shares by 5 p.m., while the stock was still trading around $165.
The next morning was a different story, as all market participants had a chance to weigh in on Nvidia’s results. Nearly 2.3 million shares traded between 9:30 a.m. and 9:35 a.m., more than three times the volume in the first minutes of the previous day’s after-hours trading, and the price fell from $164 to $161.
The stock continued to fall throughout the rest of the day, eventually closing at $157.20. After being up nearly $15 in the after-hours session, that was only $3 higher than the previous day’s close. Almost all of the after-hours gains had vanished.
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