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After-Hours Trading Arrives to the Small Investor, But Beware Before You Leap
It's 4:30 p.m., and your favorite company has just announced earnings that blew past forecasts. You're anxious to scoop up more shares of the stock.

In the past, your only choice was to restrain your enthusiasm and wait until the morning. But now, with the onset of after-hours trading, small investors may be able to act on their instincts immediately, a privilege previously reserved for large, institutional investors.

Indeed, after-hours trading for individual investors is set to take off, fueled by the exploding popularity of online trading and the growing influence of Electronic Communication Networks (ECNs), a computerized system for buying and selling securities.

Some discount brokerages, such as E*Trade, Charles Schwab, Datek and Fidelity Investments, already offer trading for a few hours after Wall Street's traditional, 4 p.m. close. And full-service brokerages such as Salomon Smith Barney, Morgan Stanley Dean Witter and Merrill Lynch either now offer or plan to present the option to clients this year.

Still, the trend has yet to catch on in a significant way, in large part because neither of the major stock exchanges — the New York Stock Exchange and the Nasdaq — have extended their formal trading hours. Both plan to offer some extended trading later this year, but until they do, only a handful of the most popular stocks will be available for trading after the bell.

Indeed, only about 3 percent of Nasdaq's stocks and a half percent of the companies listed on the NYSE are traded after hours, according to Haim Mendelson, a professor at Stanford University's Graduate School of Business.

And that's the problem. Because only some stocks now are regularly traded after hours and because major brokerages aren't required to accept after-hour orders, as they would be if the NYSE and Nasdaq were open, trading volume is low. Thin trading volume usually increases volatility, which means investors may not always get their trades executed at the best possible prices.

Nevertheless, many predict it's only a matter of time before after-hours trading becomes the norm.

Last September, eight ECNs — Archipelago, Bloomberg Tradebook, Island, Instinet, The Brass Utility LLC, MarketXT Inc., REDIBook TM and Strike Technologies LLC — signed a letter of intent to create an electronic, after-hours securities trading network.

In just two years since their emergence, ECNs now account for 30 percent of Nasdaq's trade volume, and 5 percent of the volume on the NYSE.

And with ECNs chipping away at their daily volumes, the Nasdaq and NYSE have both said they eventually will extend trading hours past the current 9:30 a.m. to 4 p.m. session.

"If the Nasdaq extended hours and investors got access to better pricing we could see 24/7 trading," said Robert Sterling an analyst at Jupiter Communications.

Beware of Skittish Prices

But before small investors plunge in, they should be forewarned, analysts said.

Investors may have a tendency to overact on company news, since many publicly-held corporations make financial announcements shortly after the stock market closes. After issuing reports, company executives often hold conference calls with analysts, giving professional investors an advantage over individual investors.

Small investors also could become confused at what prices to buy or sell stocks, especially with the proliferation of ECNs.

The process works like this: Investors place a trade, and their brokerage routes it either to a market-maker or an ECN, which automatically matches buyers with sellers. If there are no sell orders for a particular stock, investors must wait for a matching sell order to come in before a trade occurs.

But what this means is that an individual whose broker uses The Island will receive one set of prices, while an individual whose broker uses Bloomberg Tradebook, might get another.

A huge difference in price could result, and investors won't know about such discrepancies. The problem could be exacerbated if only a small number of people are trading, since prices tend to swing more wildly than when many bidders are competing.

"The average investor doesn't usually understand the potential illiquidity and volatility that exists," said Kevin Ward, vice president of trading Market Wise Securities, a firm offering electronic order execution. "It does mean the investor has to become more sophisticated."

Small Investors Should Not Be Denied Access

Despite such reservations, many welcome the added access for small investors.

"Access is great, it's wonderful for the individuals who have been historically locked out — the bunch of Americans that work the traditional nine to five," said Oliver Velez, chief executive of, an online educational service for individual investors and traders.

But he tempered his comments, by warning individual investors not to assume that greater access necessarily will lead to bigger profits.

"That's a very big misunderstanding because it's just the opposite many times," Velez said. "The automatic matching is speedy and investors go for what they see as the technological advantage they have. [But] technology is never a replacement for knowledge and training."

One way investors can protect themselves is to get into the habit of placing limit orders, which require them to specify the highest price they are willing to buy a stock, or the lower price which they are willing to sell. By comparison, market orders are filled at the offering price at the moment a trade is executed.

Several brokerages now accept only limit orders for after-hour trades. But limit orders are not glitch free.

"First, of course, you may never be able to find a match," Mendelson said. "Also if an investor has specified say, $8, at which she wants to buy, and if some negative information comes out after that order has been placed, she is locked into $8. She has to buy even if now the security is just worth $5."

One way to protect oneself from pitfalls is to consider trading only the more liquid stocks, such as Microsoft.

"With a thinly traded stock you have to be incredibly careful, because even if new information comes in, it doesn't necessarily mean a lot more shares are being traded," Mendelson said. "People make that wrong assumption often."

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