Night-Time Investing: Should You Be Trading After Hours?

Friday, September 18, 2020 8:38 AM | Neal Farmer

The vast majority of investors trade stocks solely between the standard market hours from 9:30 a.m. ET to 4 p.m. ET. Once the closing bell rings, most people stop trading for the day and go on with their lives. However, what most don't realize is that the 4 p.m. bell signals the beginning of after hours trading and that is where most if not all market growth comes from.

Market-hours returns for the S&P 500 are flat since the year 2000, and down about 20% since 1993 owing to the dot-com crash. The S&P 500 is up more than 680% since 1993 during non-market house. That 700% gap in growth show a significant difference in trading during market hours and after.

Source: The Motley Fool

Day trading is extremely difficult to pull off due to no one being able to reliably time the market. Some might get lucky and buy a stock at the day's low and sell at the day's high but there's no guarantee that those points occur in that order. Trying to pick the right stocks over very short periods of time is one of the least successful trading strategies. If the average stock is flat during the trading day, developing a system to only pick the stocks showing positive returns the day, and then executing that strategy so it profitable after trading costs is exceptionally unlikely.

A huge reason why day trading ends up being a tough game is the effect leverage has on markets. Because markets can and do move overnight, many short-term traders using leverage try to reduce their exposure, or even go entirely to cash overnight. This leads to a situation where a lot of traders open positions (buy) in the morning and close positions (sell) in the afternoon.

How to Realize Overnight Gains

The reality that almost all market gains come overnight means that buy and hold investors are the most likely to profit. Additionally, shorter-term investors who are holding for a reasonable length of time in a bull market will experience growth in many of their investments. Holding stocks for a shorter time horizon or trading option contracts carry more risk than long-term buying and holding, but will be profitable on average when you invest into reliable stocks.

These two methods will benefit from overnight trading but how about those who actually decide to trade after market hours?

Trading outside regular market outsiders used to be exclusively reserved for institutional investors and high net worth investors, but the emergence of electronic communication networks (ECNs) has changed that. ECNs match buyers and sellers directly as opposed to using a stock exchange such as the NYSE. These networks allow average investors to trade outside of 9:30 a.m. - 4:00 p.m. but carry significant risk that every portfolio manager needs to be aware of when getting started.

Far less trading occurs outside market hours meaning that volume is significantly decreased for every stock. This drop in volume means that markets will have less liquidity and increased volatility, resulting in far higher risk when buying or selling. To combat this, investors can place limit orders on shares that will only be placed at the specified price or better. The likelihood the order will be completed will drop but the increased volatility during those times may actually result in a better price than could have received during market hours. Unlike limit order, stop-loss orders, one of the key risk-management tools for short-term traders, do not execute outside of regular market hours.

How to Benefit from High Net Worth Investors

Large investors in Asia and Europe additionally have a massive effect on the S&P 500. These institutional and high net-worth investors can swing the prices of high market cap stocks during more volatile trading hours with lower volume. While the average trader is not going to have this effect on markets, they can greatly benefit from the investors who do. Go to the comment section of any investing-related article and you’ll find individuals calling out how markets are skewed in favor of the wealthy. This may be true but that doesn't mean lower-income individuals can’t piggy-back on these swings.

Whether you decide to actively engage in trading outside market hours or not, using the knowledge that market growth comes overnight will ensure that you’re stacking the deck in your favor.

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