Is premarket trading beneficial at all, or is it all a fluff? I know saying it depends is not what you like to hear, but it is the truth. To trade during premarket, your broker has to support it. You should also be aware of the limitation of order types, thin trading volume and the risk of being stopped out with huge slippage.
Premarket trading is done outside the regular trading hours, in the so-called extended market hours. The extended market hours are split into the after-market hours and premarket hours.
If you pay attention to the opening prices and the closing prices of the last trading day, you might notice that there is always a price gap. Sometimes the gap is just a few cents, and sometimes it is 10% or more. These price gaps occur between the end of the regular trading hours of the previous day to the start of the regular trading hours of the new day.
Regular trading hours for the U.S. stock market are 9:30 am to 4 pm EST. It is valid for both the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq).
The period of trading that happens before the regular hours is called premarket. This trading session is usually between 8 am to 9:30 am EST. However, some direct access brokers, such as T.D. Ameritrade allows premarket trading as early as 4:00 am.
Premarket trading was a reaction to increased competition from exchanges in Europe and Asia. These exchanges offered more hours of trading at the time when U.S. markets were closed. The rise of electronic trading was responsible for the beginning of premarket trading in the early 1990s. It was a gold mine for traders. They used the difference in prices between various exchanges to make profits without risk. These days such price differences are limited to fractions of a dollar, or even to a cent or less. In all electronic exchanges worldwide, automatic trading systems make it impossible for retail investors to benefit from huge price differences between different stock exchanges these days. Automated trading systems never sleep, and algorithms ensure that an asset is reasonably priced in all currencies on all stock exchanges.
Premarket trading strategies are often purely based on technical analysis, and sometimes early gappers are bought or sold before the regular trading hours start.
What are the advantages of premarket trading?
It might seem counterproductive to encourage traders to trade shares before the regular market hours. However, if done right, premarket trading provides significant advantages to market participants. In a bid to get ahead of other investors, institutions and experienced investors trade as soon as they receive news. It stimulates a faster exploration of price.
Premarket allows the dissemination of news to be priced in quickly. And that's the main advantage of premarket trading. It gives you an edge since only a fraction of traders use the premarket session to place their trades.
Another advantage of premarket trading is the price range traded during premarket acts as support and resistance during the regular trading hours. If prices move through premarket highs, then it is considered bullish. Vice versa, a move through premarket lows is considered as a bearish sign.
Risks of premarket trading
Institutional investors dominate premarket trading. These investors are sophisticated as they have a great understanding of trading. Plus, these investors have enough resources, both in workforce and money, to get an edge over other investors. Under such circumstances, retail investors are at a disadvantage.
During regular hours, retail participation is much higher. Also, market volatility and bid-ask spread are lower compared to premarket hours. Hence, retail investors have a lower risk.
There is enough demand for most of the stocks during regular trading hours, and hence one can trade their trades quickly. Such is not the case in the premarket, where liquidity is severely restricted. Even commonly owned stocks might have little to no volume. It can often be challenging to locate a buyer or seller because fewer traders exist. That makes it difficult to execute trades and decide on a fair price.
In the premarket, stocks are way more unpredictable. Small volume and rapid information impounding into prices lead to a lot of swings. The prices rise and fall more quickly and steeply than in a traditional market. Sudden shifts in prices could lead to severe losses for retail investors.
The range of prices exchanged for a stock during premarket hours is wide. It is possible that stock prices rise during the premarket but then fall dramatically when the regular hours opens. The price volatility may cause major losses for retail investors.
Regular protective stop-loss market orders do not work during extended market hours, so you have to sit in front of the computer all-time long to protect your investment. Also, most online brokers require a separate form to be signed before you can start premarket trading.
Can you trade during premarket?
You can trade during premarket, as long as your broker allows premarket trading. At its' launch, Robinhood didn't allow premarket trading. However, as the user base and the demand for premarket trading increased, the broker facilitated the service.
The premarket has minimal liquidity. For a majority of stocks, little activity happens in the premarket. The bid-ask spread tends to be large, and hence it might prove risky for retail investors to jump in.
The liquidity in the premarket improves when news arrives, and sophisticated investors try to outdo each other. The competition causes a significant price movement in the premarket. Hence, you will see that there is usually a considerable jump in the opening and last day closing prices on the days of the earnings announcement.
To get information about premarket trading, retail investors should reach out to their brokers. They often provide the most detailed off-hour market trading data for free. Investors would be able to not only trade but also see the current bid and ask prices. The information is also provided about the price change compared to the previous day's close.
If your broker doesn't provide this service, several free sites would you access to pre-and after-hours market data. The Nasdaq website offers a premarket quotes service. This service provides comprehensive data on shares listed on the exchange.
NYSE does not offer a service, which provides detailed information. However, the NYSE site shows you the last movements of the stocks during the off-hours market. Third-party services such as Yahoo Finance also provide such information.
Premarket trading is useful as it leads to quick price discovery. It also prevents retail investors from a rapid market swing during regular hours. Despite the advantages of price discovery, the market during the hours is very volatile and see quick and swift price swings.
Premarket might pose good trading opportunities for resource-rich institutional investors. However, one couldn't say the same about retail investors. Hence, it would help if you were careful while trading during the premarket.
Brokerage firms specialized in day trading allow trading during the pre-market trading sessions. News releases such as earnings news bring volatility to the markets, and traders can place limit orders during this period. Once the market opens at 9:30, the regular session starts.