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Here's how premarket trading works.

Just because the market isn’t open yet, doesn’t mean you can’t trade stocks. Premarket trading allows investors to make moves before official market hours. This allows investors to protect their holdings and react to off-hours news and events. However, few buyers and volatile prices make premarket trading a bit risky for novice investors.

Premarket Trading Explained

Securities markets in the United States such as the New York Stock Exchange are open for regular trading from 9:30 a.m. to 4 p.m. Eastern Standard Time. However, traders also buy and sell securities on electronic exchanges before the regular trading day begins.

These electronic exchanges or ECNs – short for electronic communication networks – don’t have physical locations. Buyers and sellers connect over a digital network.

NYSE Arca is one such ECN. It was created when the New York Stock Exchange merged with one of the early ECNs. Another ENC, Instinet, traces its beginning to the late 1960s.

ECNs permit premarket trading during different hours. Some electronic exchanges accommodate trading as early as 4 a.m. Eastern Standard Time. However, most premarket trading in the United States takes place from 8 a.m. to 9:30 a.m. Eastern Standard Time.

Trading also takes place after the regular markets close. After-hours trading generally occurs from 4 p.m. to 6:30 p.m. Eastern Standard Time. However, after-hours trading may continue until the next morning on international exchanges.

Uses for Premarket Trading

Here's how premarket trading works.

Some investors monitor premarket trading to see where the market and individual securities are headed when regular trading starts. Changes in prices and trading volumes can foreshadow the rest of the day’s market events.

Traders also use premarket trading to try to get ahead of market reactions to breaking news. Overseas events, political instability, and other factors can affect markets or individual securities.

For instance, a corporation may release an earnings announcement after the market closes. If the earnings news is considerably different from expectations, this could cause the stock to rise or fall the next trading day. A premarket trader might attempt to buy or sell early before the retail market can react to the news.

Other events that might trigger premarket interest could include a court ruling in a lawsuit or a change in regulations. If an influential analyst downgrades or upgrades a stock, that also can encourage premarket traders.

Risks of Premarket Trading

There isn’t much benefit to trading before 8 a.m. EST, but even trading at that hour can be risky. Trading may increase at that hour, but news and even rumor can broaden the gap between bid and ask prices for stocks.

Also, since fewer trades occur in premarket trading, it may be tough to find a buyer or seller. That makes executing trades and determining prices difficult, especially among stocks that trade at low volume normally. Even widely held stocks could have little or no volume in premarket trading.

Prices can be far more volatile than usual in premarket trading. Limited volume can make prices rise and fall more rapidly and steeply than usual. Traders used to more moderate trading could take significant losses from rapid premarket price changes

Even worse, prices of stocks traded during premarket hours may not reflect those shares’ prices during regular hours. Premarket trends can be deceptive. Even when stock prices appear to be rising during before-hours trading, they may drop sharply at the opening bell.

Any premarket pricing trends should be taken lightly. Typically, only the most experienced traders should attempt trading before standard market hours.

Quirks of Premarket Trading

Limit orders are common among brokerage firms that accommodate premarket trading. With a limit order in place, trades are executed only when the stock reaches the limit price or higher.

Time limits are also common in the pre-market. Time limited orders may be canceled if not executed during premarket trading. Orders entered during premarket trading may be executed when regular trading hours begins. Also, orders entered during the regular trading day may be executed during after-hours or premarket trading. Investors may want to ask their brokerages just when their premarket trades will finalize.

Competition is more intense in the premarket hours because relatively few individual investors trade then. That can put individual investors at a significant disadvantage with professional traders, who have access to more information.

You may not be able to complete a trade with another investor if you are on different, incompatible ECNs. Meanwhile, a computer delay at your brokerage can slow a trade or block it altogether.

Generally speaking, premarket trading operates under different rules than regular trading. Different ECNs and brokerages often have different rules for premarket trading, so you may want to compare and contrast them.

History of Premarket Trading

Here's how premarket trading works.

Premarket trading is a fairly new development in the U.S. In 1991, the New York Stock Exchange responded to around-the-clock global trading by allowing trading after regular market hours.

Since then, computerized trading across borders has become increasingly common and the exchanges have extended trading beyond market hours. Today, trading in U.S. markets can take place any time between 4 a.m. Eastern Standard Time and the opening bell for regular market hours at 9:30 a.m. Eastern Standard Time.

Bottom Line

Premarket trading can represent an opportunity for experienced and sophisticated investors. It’s also much riskier than trading during regular hours. For this reason, it’s more common for investors to watch premarket trading action than for them to participate in it.

Trading before the market opens will likely place individual investors in direct competition with professional investors with a lot more experience. If you still feel drawn to those early trading sessions, it may help to have a professional on your side.

Investing Tips

  • If you’re still wondering if off-hours trading can benefit you, it may help to speak to a financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • Don’t know how much investment risk you can tolerate? Still have questions about regular trading, never mind early trading? SmartAsset’s investing guide can help you determine your investment profile and see which investments might be right for your portfolio.

Photo credit: ©iStock.com/ipopba, ©iStock.com/scyther5, ©iStock.com/Milkos

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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