An Extended-Hours Trading Primer

How you too can play the after-hours market.
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Wall Street knows some investors never stop worrying about their holdings. That's why the major exchanges offer extended-hours trading.

The regular trading day, of course, starts at 9:30 a.m. Eastern time and finishes at 4 p.m. But as the earnings avalanche of the last few weeks has shown, it's not like companies stop making news outside those hours. In fact, the vast majority of big news releases are issued either early in the morning or after the close.

So for those who can't stand to wait till the next day to pull the trigger on a trade, there's preopen and postclose trading on the

Nasdaq

, as well as a brief late-day "crossing session" on the

NYSE

.

Institutional investors have long been able to trade after the market, but it's only been about five years since individuals got the right. The Big Board and the Nasdaq took up their cause in the late 1990s as electronic networks known as ECNs were expanding their hours and coverage, threatening to take some of the established exchanges' coveted customers.

So when

Google

(GOOG) - Get Report

or

Yahoo!

(YHOO)

puts up its earnings on a Wednesday afternoon, extended-hours trading gives you a chance to get in on the action before the market has had hours to digest the latest developments.

That said, most professionals caution that individual investors shouldn't wade into these waters without taking stock of the many risks. Stocks that trade heavily after hours tend to be more volatile and to be strongly influenced by breaking news, and volume can be scarce even in some of the bigger names. These factors can lead to wider bid/ask spreads that can drive up the cost of trading in preopen or postclose markets.

"The danger of trading in extended hours is the thin volume," says Randy Diamond, sales trader at Miller Tabak. "If you are not careful, you could wind up paying well above the market, or selling way below it."

But should you find the need to wade into the world of extended hours trading, here are the basics:

When Can I Trade?

Nasdaq holds premarket trading from 8 a.m. to 9:30 a.m. and after-hours action from 4 p.m. to 6:30 p.m.

The NYSE holds a so-called crossing session after the regular market closes, from 4:15 to 5. Trading is indeed thin, as this session averaged just 43,533 shares per day in 2004, the NYSE

says.

How Does It Work?

Actual trades typically take place via computerized order-matching systems known as electronic communications networks. ECNs electronically display and match buyers and sellers to execute limit orders.

Professional investors, such as institutional investors, have been using ECNs for over 15 years. Retail investors are commonly discouraged from trading in extended hours because of the lack of liquidity. Nevertheless, most brokers offer retail investors the ability to trade in extended hours if they sign a form stating that they understand the risks. (More about those below.)

Most brokers also maintain restrictions on after-hours trading. Fidelity, for example, has no minimum order but a maximum order of 5,000 shares.

What Moves?

A look at the

Nasdaq most actives for the early and late sessions shows that action is concentrated in a few mega-cap names such as

Cisco

(CSCO) - Get Report

,

Microsoft

(MSFT) - Get Report

and

Intel

(INTC) - Get Report

-- along with some smaller players that are in the news at the moment, as with earnings reports, executive changes or other headlines.

If trading is halted in a given security on the primary stock exchange, then that security will generally not be eligible for trading on the ECN. The rules of Nasdaq and NYSE governing stock halts apply to the extended hours trading sessions as they do to other sessions.

What Should I Know?

Fidelity Investments warns investors that trading through an ECN in extended hours poses certain risks. These risks include lack of liquidity, greater price volatility and price spreads, limited access to other markets and market information, price variance from standard market hours, the time and price prioritization of orders, and communication delays. These risks may prevent your order from being executed, in whole or in part, or may prevent you from receiving as favorable a price as you might receive during standard market hours.

Price volatility usually refers to the speed and size of changes in the price of a stock. There may be more volatility in the extended hours sessions than in the standard day session, because of the lack of buyers and sellers.

Price spread generally refers to the difference in prices between what you can buy a security for and what you can sell it for. Lower liquidity and higher volatility sessions may result in wider than normal spreads for a particular security.

If that sounds like a bunch of legal nonsense, it boils down to this: Stocks often make big moves in the after hours that don't hold up. So if you're not careful, you can wake up the next morning to find you've lost a bunch of money.