Limitations, issues costs and liquidity with extended-hours trading

Extended hours trading can be very volatile when there is news released on the company after-hours or before the market opens. Most of the after-hours markets function as crossing markets. That is, an extended hours trader's order and another extended hours trader's opposing order are filled only if they can be matched (i.e., crossed). In an extreme example, the new Market XT requires ONLY limit orders. The concept of trading after exchange hours seems attractive, but it brings with it a new set of problems. Most importantly, the traditional liquidity that the daily market offers could suffer.

The NYSE has a regular trading system where, the specialist ("specs") in the NYSE are required to act as buffers by buying and selling for their own accounts. This serves to smooth out market action. In the case of the NASDAQ, an all-electronic exchange, many firms may offer to "make a market" in a specific stock. They post buy and sell offers on a computer system and when there is a matching counter offer, the trade is made. Meanwhile, onlookers can see the trading potential of all available bid and ask quotations - a decidedly different situation than on the NYSE. But note that the NASDAQ system has no buffering built in (no market maker is required to buy or sell). Those methods are absent on the electronic communication networks. Furthermore, Instinet, Island and all the other ECNs don't have a common reporting structure as do NASDAQ and NYSE. That is, the prices and volumes on one ECN might be different from that on another ECN. Since only a few of the biggies have access to multiple ECNs there can be a chance for arbitrage, which means buying in one place at one price and selling substantially the same thing somewhere else for a different price, all in essentially the same time frame in the case of ECNs.

The effect is widened spreads, irregular trading, and a chance for the unwary (read new traders) to get slightly whacked.

There are other issues as well, of course. At night, the information resources and public attention that the established exchanges offer today will be operating at a low level. Today, Microsoft, Intel, or Dell likely make important announcements during the quiet hours after the exchanges close. That gives the investment community time to access and evaluate the news. Now drop the same announcement into an environment of several uncoordinated after-hours exchanges. Favorable news may create such demand that it overwhelms the supply offered by now reluctant sellers. Prices could zoom, only to crash back as more sellers show up. Lack of full information and considered analysis could make the daily gyrations of hot stocks look boring.

Most brokers charge the same price for regular and extended-hours trading. (However, some firms impose a higher price in all cases for limit orders, which are recommended for extended-hours trading.) But there is more to extended-hours trading costs than just commissions. Extended-hours stock prices may not always "track" with stock’s closing price during regular hours or the stock’s price when the market reopens.

Lack of liquidity (an insufficient number of buyers and sellers that can make it harder to get the price extended hours traders want for a stock), volaitle price swings and limited information about price quotes are among the additional factors that sometimes contribute to higher costs in extended-hours trading.

Future

The SEC is pushing for some rules and regularity. To get the blessing as a recognized exchange, expect that the SEC will insist on a public ticker system (ultimately an expert thinks that there will be one unified quote system incorporating all of today's exchange's and the ECNs.) Logically, this leads to expectation of a unified market, and represents a significant threat to existing markets like the NYSE.

Certain indications suggest that extended hours will become even more extended (possibly approximating a 24 hour market) in the foreseeable, though perhaps remote, future. In the past few years, market forces have constricted efforts to further extend trading hours, but a strong enough future bull market would almost certainly reverse that trend.