Extended Hours Trading Dilemma
by Mike Mc Mahon of TradingAcademy.com

Question:

If you want to help potential traders - you should really spell out the dangers of out of hours trading. I lost money when a share - Teva Pharmaceuticals - was suspended when the NASDAQ opened - allowing traders using brokers with out of hours trading facilities to take huge positions - the share dropped in excess of 600 points in 1 hour and 20 minutes. - Ann

Answer:

Hi Ann,

Thank you for your comments and question. Yes, we really do wish to help new traders find their way through the maze of the markets. That is why we teach. Unfortunately, many people think that they can quickly master an animal that takes years of study to understand. We try to improve the learning curve through our various curricula.

Certainly, in class, we talk extensively about the Extended Trading Hours (your Out of Hours). First, people are eager to take advantage of a piece of news or information that they believe is pertinent and substantial - so they rush to judgment, and try to get a "leg up" on the market. The Extended Hours are traded primarily by small firms and individual traders, thus you tend to see small share sizes which have a lot of impact on a stock's price.

As an example, AMZN is a fairly well known stock. In extended hours this morning (12/19/03), it was moved .25% from last night's close by only 76,470 shares while its ADV (Average Daily Volume) is over 4 million shares - a stream of 10,256 shares per minute on average. So as we look at the early trading, we see price being moved by 100 shares here, 200 shares there and an occasional 2000 share, which is still not a big size. But it did affect price. However, when the Market Makers (& Pro Floor Traders) open the stock officially at 9:30 AM EST, they knock it right back where it should be, so often the early gains evaporate.

That being said, occasionally the major brokerages can use the ECN's (Electronic Communication Networks) to their own ends. By demanding or supplying large share size anonymously through the ECN's, they can jump on news early. When this happens, and it appears this is what you asked about TEVA, then price can move dramatically and stay there due to the sticking power of the MM's.

So, what have we learned form this? You must understand that there is only one coin in the market - on one side is Risk and the other side is Reward. You can not have more Reward without accepting more Risk. Holding a position overnight is often very rewarding. You buy it long and it gaps up nicely the next day on news. Remember this little saying, "Good News lasts from 1 hour to 1 day, Bad News lasts from 3 hours to 3 days".

The reality of the situation is that nice reward is at the risk of something happening over night that you cannot control or foresee - Capturing Osama Bin Laden, or an airplane wreck, a volcano, hurricane or other extraordinary item. And these, and a gazillion more, may affect the price of the stock you are in. So, Unless you can afford the risk, you cannot afford the reward. That then says, "Do Not Hold Overnight".

What then of the Extended Trading Hours? They are run thinly on others' belief systems - things they know, things they think they know, and things that they have simply heard without confirmation. This is no way to run a trading business, this is gambling. So, the rule here is simply do not trade in the extended hours until they are more robust and the global community has access to the information driving the market. We are heading for 24/6 trading at least. Much like the Forex markets and Futures markets, the stocks will eventually follow along.

Until there are shares traded with high liquidity during those hours, do not open positions - simply this and no more. Again, the allure is the Fast Buck - the answer is a trading plan that you follow zealously.

Last on the Extended Hours - we teach our people to stay out, but that does not mean that you cannot use them as an "escape" or a 911 emergency route. Here you are, taking your first long home overnight. It has had good earnings, a steady trend and closed near its high for the day and on high volume - a fairly high probability that it will move up. An hour after the market officially closes, you see a news piece that the CEO and the CFO of that company were in a plane crash together. If such a case happens, jump into the Extended hours and close the position. It won't get better when all the public comes home from work and see the news on the 6 pm news channel. It will not heal itself overnight, it will only get worse as the news spreads and more people start to sell. So, take your loss early and get out. We, at OTA, love the saying, "When in Doubt - Get Out!"


In a nutshell:

1.) Beginners or limited accounts should not be in overnight holds.

2.) Entering a trade in any limited liquidity situation is more a gamble than a trade plan - Extended Hours Trading is limited liquidity.

3.) Inspect your motives - greed and fear are probably at the roots of your actions. Are you trading or gambling? - be honest with yourself.

4.) Use the Extended Trading Hours to escape if necessary.

5.) Know that the trading will become more robust in the next few years - but that is still years away.

6.) Get a formal education so you clearly understand all the pitfalls and opportunities the markets offer. The trader who reads a book or two and tries to trade, usually ends up as a statistic in a book or two.

I hope this helps. We try to help but cannot answer the world's questions all at once- we will need a little time :-)

Mike Mc Mahon, Lead Instructor - OTA

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