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What does the term "extended hours" mean? I have noticed it on several stocks I have, and it is different than the closing price. How does it affect the stocks, and how does it work? I thought when the market closed for the day that was it until the following day's trading. -- R

Many investors have probably noticed -- via

Yahoo! Finance

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or a similar site for stock quotes -- that a stock's price moves not only during the normal 9:30 a.m.- to-4 p.m. trading day but also before the open and after the close each day.

This is what is referred to as extended-hours trading, a practice that has become more common with the rise of ECNs (electronic communications networks), which directly match up buyers and sellers of particular stocks. Many brokerages such as E*Trade allow their customers access to these ECNs, provided they fill out a special trading agreement and are willing to pay an additional, per-share ECN fee.

The after-hours market exists because, well, some institutions and individuals want to be able to make a trade beyond the limits of the normal trading day. And in the world of finance, where there's demand for a product, someone will come up with that product. However, the majority of investors (especially beginners) should stay away from extended-hours trading because of the higher risks and extra fees.

Beware of Thin Volume

There are a number of characteristics that set apart extended-hours trading from the normal trading day. The volume in the extended-hours market for a particular stock usually will be most busy immediately before and after the company's earnings announcement, which typically happens when the regular market isn't open. However, even when busy, the volume and liquidity in the extended-hours market is extremely thin compared with an average daytime trading session.

This lack of liquidity results in a wider spread between the bid and ask prices (the prices at which someone can buy and sell their shares), as well as an inability to buy or sell a large number of shares without moving the market.

Example: Selling Wal-Mart 'After Hours'

To give an example of how the extended market works, if an individual puts in an order to sell shares of

Wal-Mart

(WMT) - Get Report

at $47.25 and there is no opposite order to buy shares at the same (or higher) price, then the order will not be filled.

While this is similar to what happens during the daytime market, let's say that the last trade for WMT occurred at this $47.25 price during extended-hours trading, and because you saw WMT close at $46.50 today (i.e., WMT's closing price) you think, "Hey, that's a good price to sell at." So you put in an offer ("after hours") to sell 100 shares, and the trade goes through because someone else had a $47.25 bid.

Now at that moment, you may think that you made a good sale, but when the market opens again, shares of WMT are trading at $49. How could this happen? Because the majority of buyers and sellers do not participate in the extended-hours market, the extended-hours price is often not a fully accurate representation of how most of the investor population is valuing a stock.

While this WMT scenario is just an example, it does a good job of illustrating why most investors are better off executing their trades during normal trading hours.

In keeping with TSC's editorial policy, Larsen Kusick doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Kusick is a research associate at TheStreet.com, where he works closely with Jim Cramer and works on TheStreet.com Stocks Under $10. Prior to joining TheStreet.com, he worked in options trading and management consulting. He appreciates your feedback;

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