You have seen references to premarket trading in newsletters you subscribe to. What is the premarket? How does it work? Could you (Should you?) be using it to trade?
What is Premarket Trading?
It’s pretty obvious really. Premarket trading happens before the 9.30 am Eastern Tine opening of the main market, according to IG. There is postmarket trading too, which happens after the market closes at 4 pm ET. Premarket trading starts at 4 am, but it depends on the broker you use, some only support trading from 6.30 am.
Historically, only institutional investors could trade in the premarket, but things have changed. Many brokers now allow small traders access to premarket trading. If you want to learn how to trade like a pro, join StocksToTrade Pro for more info.
What’s Different about the Premarket?
Alternative Trading Systems
How does the stock market work after the brokers have left for the day? Brokerage companies have alternative trading systems (ATSs) in place for out-of-hours trading. Sometimes these are called electronic communications networks (ECNs).
There is a problem here for anyone wanting to trade in the premarket. Each broker has its own ECN and different ECNs don’t always talk to each other, says USNews. This means you will only get quotes from your own broker’s ECN rather than from the entire market as would happen during trading hours. Some brokers will show quotes from other brokers, but won’t let you trade.
Liquidity is much lower in premarket trading. This matters because fewer traders are buying and selling, so you might find it harder to sell your position when you want to. You might have to sell for less, or you might not be able to sell at all, for any price.
Brokers charge more for premarket trades. You need to read all the small print.
Wider Buy-Sell Spreads
Spreads are wider, partly because there are fewer people in the market.
Type of Trading Allowed
You can only place Limit Orders where you specify a price for your trade to be executed. If that price isn’t reached your trade doesn’t happen. This isn’t a disadvantage as such but is a limitation on the trading you can do.
Prices go up and down more when there are fewer people trading. This might be seen as a reason to be in the premarket, but low liquidity, higher charges, and wider buy-sell spreads will all eat into any higher profit you might make.
Why Trade Before the Market Opens?
Maybe you see the extra profit potential from the higher volatility.
Perhaps you want to trade when relevant news is announced hours before trading officially begins.
Unfortunately, these scenarios rarely work out. Bigger price changes are wiped out by higher charges and wider spreads, and every trader has access to the same news feeds as you, so bargains are few and far between.
Managing Your Premarket Trading Risks
The additional risks mean only experienced traders should consider premarket trading. It is not for everyone.
You can reduce your risks and exposure to losses.
Pay for Good Advice
The first step is to sign up for a pro-level trading advice sheet. You are paying for advice that should improve your trading. Think of it as the entry price to successful trading. Free tips in the Sunday newspapers and from bloggers are NOT the same thing. In the best-case scenario, they might be accurate, but so many others are reading them you will struggle to make profitable trades based on them. In the worst-case scenario, they are no better than a horse racing tip you pick up at a bar.
Trade Only with a Catalyst
Liquidity is the BIG problem with the premarket. You need to find the stocks that other traders will also be looking at. News stories are the big catalyst you need. It could be a financial report from the company, a regulatory change, or a widely-read Twitter post. Look for obvious benefits to the stocks you plan to trade.
Avoid Large Trades
It might be hard to get a good price for a large batch of shares because when you come to sell, partly because of the reduced liquidity and partly because other traders might think you know something they don’t.
There might be no buyers for your shares until the main market opens. If the price crashes you’ll be glad it was only a small trade.
Get More Data
There are five levels of data access. Level 1 is adequate for trading when the market is open. You need Level 2 data if you plan on premarket trading. You will have to pay your broker for this data feed, but it will be worth it.
A Level 2 screen will give you a list of buy and sell trades on offer.
The left side of the screen lists BUY orders, the orders traders have placed to buy your chosen stock, and the prices they are prepared to pay. The right side of the screen lists SELL orders traders have placed and the prices they will sell at.
If you have access to Level 2 trading you can see how many buyers and sellers are active in the stock you are looking at before you buy it.
Choose VERY Carefully
Avoid placing any trade unless all the conditions are perfect. Too much can go wrong leaving you saddled with those stocks until the market opening bell when the price might have fallen substantially.
Should YOU Consider Trading in the Premarket?
You may be allowed to trade in the premarket, but whether you should is another question entirely.
One of the essentials of trading is to only buy stocks you can sell easily, stocks with high liquidity. These are few and far between in premarket trading.
If you plan to trade in the premarket you should make a few hypothetical trades and see how they work out, though even doing that. Use your Level 2 data to estimate the price you could have sold at.
Make sure you understand the risks of trading before you start. The extra risks and brokers’ charges will put off many would-be early morning traders.
Should You WATCH the Premarket?
Definitely. Stock price movements in the premarket can give you a clue as to what to expect when the market opens. They help you plan your trades for the day.