How To Detect Mispriced Stocks; All About After-hours Trading its Risks And Benefits
After-hours trading takes place during the hours subsequent to the market close at 4.00 pm to 8.00 pm ET. Even though these are not regular stock market trading hours, investors can still engage in market activity, even though it’s a slightly different playing field. Investors can still take advantage of price differences and mispriced stock as long as they can maneuver the risks and benefits involved in after-hours trading.
Benefits involved with trading after-hours
Trading after-hours has some benefits to a trader as they can find ways to stay ahead of other traders who only limit their activity to regular market hours.
Better chances to react to fresh information
One of the most common reasons people prefer after-hours trading is because they want to react to fresh news before other market players do. Financial trading is a very information-sensitive industry, and that is why traders prefer to get news early and calculate their moves to take advantage of any predictable market shifts. In this case, if an investor suspects that adverse news will make the price of a share fall, they may want to sell it off at market prices instead of waiting for it to fall further.
There is some high volatility experienced during after-hours trading. Even though high volatility may be a problem to some investors, it also brings about some very attractive prices that may be appealing to certain traders. Speculators have high chances of trading shares at marginally better prices than they closed.
Risks involved with trading shares after-hours
Even as stock market players find a less-crowded space to trade-in during the after-hours, it also bares with it some increased risks. Here are some characteristics of after-hours trading that make trading challenging.
During after-hours trading, stock prices get highly volatile, unlike in-session trading. In many cases, the price changes are more sudden, and are more pronounced. Because the after-hours market is thinly traded, fewer orders can make the price change by a bigger percentage. The lower volumes mean that each single trade has a higher effect on the whole price movement.
The biggest disadvantage has to deal with wider spreads. As already noted, after-hours trading has lower trade volumes than session trading, resulting in wider spreads. The bigger difference between the bid and ask prices often makes it harder for the trader to execute orders within their price preferences. High spreads are generally a turn-off to most traders who want to make high-frequency trades such as scalpers. High spreads require traders to target a higher price movement so that they can maximize their profits after the cost of the spread is factored in their trading strategy.
Liquidity thins out during after-market trading. There are fewer people swapping shares or contracts during that time, making it costlier to move large tranches of stock at once. To make it worse, due to the smaller trading volumes, immediately converting all your shares to cash becomes more difficult.
Competition from institutional traders
Even as individual investors have a good opportunity to profit from the volatility experienced during the after-hours, they still need to compete against institutional investors. The individual investor still has to face institutional investors who most likely have more resources than they do.
Price gaps and mispriced stocks
Price gaps occur mainly because of overnight news. Different kinds of news such as political news, geographical catastrophes, or company-specific news can cause a price gap. The gaps can be larger if the news is more destructive. In many cases, when companies decide to release the news overnight, the stock price may experience a gap up or down during the next opening bell. Many traders usually expect a strong momentum from the previous trading day to continue the next day and will bet on a gap in the same direction on the next day’s open. Note that it is a purely speculative viewpoint, and therefore it is not always guaranteed to happen.
A great concern about price gaps, however, is that they are usually hard to predict. Some people argue that price gaps are going to be filled anyway as the market price tends to correct. This makes some people want to wait for the price to go back to the previous closing price before making its next move. If looked at keenly, an opportunity still exists there because a risk-averse trader can still make some profits if they place orders expecting a gap to be filled. The price action actually goes back to the previous close during the first moments of the market open.
The reason why companies strategically time their news releases after-hours
Most companies will hold out their earnings reports and disclose them after-hours if they predict that it will adversely impact its price. The practice is not unethical or misleading in any way, but the overall aim is to release the news during a period when fewer people are likely to follow the news. In other cases, the companies will disseminate the release when there is already another cluster of economic reports expected at the same time. Such timing of news usually takes the attention off the company stock.
The opportunity to make market moves while the rest of the trading crowd is not watching, gives stock traders a competitive edge. Therefore, venturing into after-hours trading is a good idea if the stock trader understands the different market environment and the challenges it brings. These may range from low liquidity to high volatility and higher costs due to spreads. However, like in high volatility, what appears to be a disadvantage to one trader can be an advantage to another trader. After-hours trading is profitable if the stock traders clearly understand their intentions and can match their risk appetite to the trading conditions that are common after hours.