After Hours Trading
Pre-market trading in stocks occurs from 4 a.m. to 9:30 a.m. EST, and after-hours trading on a day with a normal session takes place from 4 p.m. to 8 p.m. With the rise of electronic trading, and trading hours extended beyond normal working hours, there is a tendency for traders to be drawn into trading during these periods. Note that not all brokers allow after hours trading, and those that do usually require that you ask permission and also limit the types of trades that can be made during that time.
We are not fans of trading during these periods, and will explain below why that is.
Low Volume
There are far fewer eyeballs on the market before and after normal stock market trading hours. As a result, the volume after hours is considerably lower than it is during the trading day. Lower volume means less liquidity, which tends to mean wider bid/ask spreads. That in turn means you'll be paying more to both get into a trade and to get out of a trade.
In addition, because there are fewer traders, the ones that are there are more likely to be professionals, with more money, more information, and more experience than you. We'll explain in the next section how that hurts you, the small fish.
Manipulation
Lower volume also opens up the possibility for "legal" price manipulation. The sort of manipulation that an Average Joe retail trader might not recognize. There is a famous clip of CNBC's Jim Cramer describing how he manipulated these markets for his own gain and implored all hedge fund managers to do the same. And no, he never received any disciplinary action for this, and neither has anyone else.
Basically, how the manipulation works is like this: Someone is long 100,000 shares of a $20 stock ($2 million). Obviously, they would like the price to continue to go higher. Now, in pre-market trading they see that there are only 1,000 shares being offered for sale at $20.50, and 1,000 shares at $20.75. They can easily buy these shares with hardly any risk to themselves. In other words, if the stock ends up opening back at $20 during regular hours, they don't really care. The difference to them of 100,000 shares and 102,000 is meaningless. On the other hand, there is the possibility that traders will look at the pre-market stock trading at $20.75 and think that is really where the market for the stock is, without realizing it is only there because of the incredibly low volume. When regular hours trading opens up there is a better chance of buyers showing up at these higher prices. What they have done is shifted the perception of the fair value before the market opens.
This kind of manipulation only works in after hours trading. During normal market hours the liquidity is too great.
Why Bother at All?
The only time the average retail trader like yourself need be concerned with after hours trading is when the price of a stock moves to your already predetermined target price for a trade. If the market will let you book your winner at night, instead of waiting until the market opens the next day, you can probably take that opportunity.
What if your stop price is hit in after hours trading? Ignore it. Wait for the volume and liquidity of normal market hours to determine if the stop has indeed been hit legitimately.
Overall, our advice to traders interested in after hours trading? Ignore it. Get some sleep instead.