Written by True Tamplin, BSc, CEPF®
Updated on June 21, 2021
Pre-market trading is a time period of trading activity before normal market hours. Pre-market trading begins as early as 4 am EST and goes until normal market hours, which begin at 9:30 am EST. Not all brokers offer this service to their retail clients. The ones that do often customize their pre-market trading service offerings. For example, they may offer pre-market trading only between 6 am to 9:30 am. Pre-market trading can only be conducted through Electronic Communication Networks (ECN) that match buy and sell orders electronically, instead of through a traditional stock exchange like the NYSE. Pre-market trades are processed as “same day” trades with settlement occurring three days after the actual date.
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Preparing for Pre-Market Trading
The New York Stock Exchange (NYSE) introduced premarket trading in 1991. Earlier, the NYSE, Nasdaq, and other exchanges provided similar services using other technology services, such as SelectNet, Automated Confirmation Transaction Service, Nasdaq Trade Dissemination Service. After its introduction, the Pre-Market trading service was initially reserved for institutional investors and High Net Worth Investors (HNI). The development of ECN networks enabled deployment of the service to retail investors.
It offers traders indicators for that day’s regular sessions, including active trading stocks and overall market movement and direction. Pre-market trading is characterized by low levels of liquidity and volume and big “bid-ask spreads,” or the difference between what buyers are willing to pay and sellers are willing to sell for. Large institutional firms are key players in pre-market trading.
Preparing for pre-market trading involves checking several sources of information. Some of them are:
- News developments: Headline news can have a significant effect on a company’s stock price movement. For example, a company’s stock price may fall if it announces an acquisition despite rocky finances.
- Earnings releases: Earnings releases are generally released before or after trading hours and are responsible for price swings. For example, a company’s stock may skyrocket on account of better than expected earnings.
- Economic reports: Many important economic reports are released prior to normal trading hours and can trigger swings in the market. The nonfarm payrolls report and producer price index are two examples.
- Futures: Generally trading in futures contracts can be signals of market movement for the day. For example, S&P futures are often seen as setting the tone for the S&P 500 index’s direction for a particular day.
Using Pre-Market Signals for Trades
While pre-market trading can offer clues to market movement, much depends on a trader’s interpretation of available facts. Trading volume in pre-market trading is relatively thin as compared to the actual trading volume during regular sessions. The difference can magnify price swings, leading to a distorted view during pre-market trading. News developments during the day can further influence a stock’s price trajectory and market direction. As such, pre-market moves may not always be indicative of the magnitude of a market move during a regular session and should be interpreted carefully.
For example, consider the case of stock ABC. A news outlet reported that ABC, whose stock was sliding downward due to negative earnings outlook, was rumored to be an acquisition candidate for a major conglomerate. Its stock price quickly jumped by more than 15 percent in pre-market trading. The steep jump in its price was due to the lack of liquidity in pre-market trading. A trader might attempt to get in on the action by buying the stock at the inflated price, hoping that it will appreciate further as other traders join the party after market opening. However, after the markets launched trading for the daily, a second news report stated that the rumor was unfounded and ABC’s price crashed, leaving the trader with losses. During normal market hours, the presence of liquidity and skeptical traders might have arrested ABC’s stock jump or cut back the percentage figure of its increase.
Limit orders are a useful tool for traders to curtail their losses. Such orders are not executed unless a price target specified by the trader is reached. You should check with your broker to see if they support limit orders during pre-market trading.