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(Fred Lum/The Globe and Mail)
(Fred Lum/The Globe and Mail)

INVESTOR CLINIC

Beware of the risks that lurk after hours Add to ...

When a company announces important news after the markets close, we often read that the shares rose or fell in “after hours trading.” Where do these trades take place and can small investors participate?

North American stock exchanges are typically open from 9:30 a.m. to 4 p.m., but investors can trade outside these hours through “electronic communications networks” (ECNs) – computer systems that facilitate buying and selling of stocks and other financial products.

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After-hours trading generally runs from 4 p.m. to 8 p.m. There’s also a “pre-market” session from 7 a.m. to 9:30 a.m.

Extended trading is dominated by large, sophisticated financial players, but small investors can also participate. However, there are often restrictions on when and how orders are placed, and after-hours trading also entails special risks compared with buying and selling during the regular exchange session.

For example, my discount broker – BMO InvestorLine – requires that orders for after-hours trading must be entered with an agent as opposed to online. The commission is a flat $43 – higher than the $9.95 fee charged for online trades (when the account has at least $50,000 in assets).

BMO InverstorLine’s after-hours session covers stocks on the NYSE and Nasdaq, and lasts until 7 p.m. However, orders must be submitted by 5 p.m. to qualify. Each broker has its own rules, commission and hours for extended trading, so be sure to do your homework before placing an order.

You also need to be aware of the risks. One of the biggest drawbacks of after-hours trading is that the market is not as liquid as during regular market hours. The lower volume can lead to wider spreads between bid and ask prices and greater volatility. What’s more, compared with regular stock exchanges after-hours trading offers far less transparency, with price quotations that may vary from one ECN to the next.

“Depending on the extended hours trading system or the time of day, the prices displayed on a particular extended hours system may not reflect the prices in other concurrently operating extended hours trading systems dealing in the same securities,” Interactive Brokers warns on its website. “Accordingly, you may receive an inferior price.”

The fact that after-hours trading is dominated by professionals and institutions also puts the retail investor at a disadvantage. Some people are under the impression that by trading after hours they can avoid a big loss when a company releases lousy results after the close. But when bad news breaks the impact on the stock price is immediate; you might even suffer a bigger loss if you sell after hours because prices are so volatile.

If you want to see for yourself how wild the price swings can be, go to marketwatch.com – a U.S. website that provides after-hours quotes – and enter the stock symbol after a high-profile company such as Apple releases quarterly results.

Another thing to keep in mind: Because of the illiquid, volatile nature of after-hours trading, brokers will usually accept only “limit orders,” which specify a maximum price (when buying) or minimum price (when selling). This is in contrast to “market orders,” which are filled at the best available price.

After-hours trading is largely confined to U.S. stocks, but some Canadian shares inter-listed on U.S. exchanges also qualify. However, trading is often extremely illiquid in these stocks and bid-ask spreads are wide, a rep with one of the big Canadian brokers told me.

Given the uncertainties with after-hours trading, most retail investors are better off doing their trades during the regular stock market session when they’ll benefit from greater transparency and liquidity. After all, your goal as an investor is to control your risk, not add more.

Follow on Twitter: @johnheinzl

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