Ken Trester

Prices Can 'Jump' in the Night

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We've all had it happen: A buy order placed after the closing bell blows up in your face and you awake to find the option premium has skyrocketed overnight. How does such significant movement happen?

Isn't the market supposed to be closed? Yes and no.

For many years, only big institutional buyers had access to the trade after the closing bell rang at 4 p.m. Eastern. Then, in 1999, individual investors were given access, as well, a move that was made far easier by the advent of electronic communication networks (ECNs).

The ECNs are applications that act as agents, offering a place where buyers and sellers can display and match their orders 24 hours a day. The ECNs don't actually make trades themselves, but they receive a fee for every transaction. Interestingly, while anyone on the ECN could see transactions that individual stock investors make, big institutional investors can trade anonymously, thus concealing their actions.

It can be frustrating as market makers are shifting billions of dollars out of everyone's view. They also have an advantage because many firms report earnings or other significant items overnight, so after-hours traders can act on the news before you've even had your first cup of coffee.

Knowing this, many individual investors are tempted to foray into the after-hours dimension, but that bears a lot of risk. Decreased liquidity is chief among them because there are many more players during regular hours, so the after market likely means less trading volume for your stock and more difficulty converting shares to cash. Less trading volume also goes with increased volatility, so watch out for wild price fluctuations.

There's also a chance for wider spreads between bid and ask prices, so it may be hard for you to get your order completed at a good price. That's partly because, as an individual investor, you're competing against large institutional investors who have more capital than you.