Pre-Market Trading: How It Works, Benefits, and Risks (2024)

What Is Pre-Market Trading?

Pre-market trading is the period of trading activity that occurs before the regular market session. The pre-market trading session typically occurs between 8 a.m. and9:30 a.m. EST each trading day. Many investors and traders watch the pre-market trading activity to judge the strength and direction of the market in anticipation of the regular trading session.

Pre-market trading can only be executed with limited orders through an "electronic market" like an alternative trading system (ATS) or electronic communication network (ECN). Market makers are not permitted to execute orders until the 9:30 a.m. EST opening bell.

Understanding Pre-Market Trading

Pre-market trading activity generally has limited volume and liquidity; therefore, large bid-ask spreads are common. Many retail brokers offer pre-market trading but may limit the types of orders that can be made during the pre-market period. Several direct-access brokers allow access to pre-market trading to commence as early as 4 a.m. EST from Monday through Friday.

It is important to remember there is very little activity for most stocks so early in the morning unless there is news. The liquidity is also extremely thin, with most stocks only showing stub quotes. Index-based exchange-traded funds (ETFs), such as the SPDR S&P 500 ETF (SPY), have moving quotes due to the trading in the S&P 500 futures contracts. Many of the most widely held top holdings in benchmark indices may also get movement in the event of a significant gap up or down in the S&P 500 futures. Large-cap, widely held stocks such as Apple Inc. (AAPL) tend to get trades as early as 4:15 a.m. EST.

After-hours trading was introduced before pre-market trading. The New York Stock Exchange (NYSE) introduced after-hours trading in June 1991 by extending trading hours by an hour. The move was a response to increased competition from international exchanges in London and Tokyo and private exchanges, which offered more hours of trading, and 2.24 million shares changed hands in two sessions of trading. Over the years, as exchanges became increasingly computerized and the Internet's reach spread across borders, NYSE began extending the number of hours of trading available for trading, eventually allowing pre-market trading between the hours of 4 a.m. and 9:30 a.m.

Pre-Market Trading: Benefits

Pre-market trading and after-hours trading—collectively known as extended-hours trading—share similar benefits and risks. Let's look at the benefits first:

• Provides an opportunity to react early to overnight news: Pre-market trading provides the retail investor with an opportunity to react to overnight news before the regular trading session commences. Such news could be corporate earnings (although most companies report earnings after markets close, rather than before the open) or a major company announcement, overnight breaking news such as a geopolitical development, or news emanating from overseas markets. The caveat here is that the pre-market reaction to such news may reverse in the regular trading session. The limited trading volume in the pre-market may provide a signal of weakness or strength that may not be borne out when the market opens and regular trading volumes are reached. For example, a stock that reports an earnings miss may be down significantly in pre-market trading but could reverse course and end the day higher in the regular session.
• Convenience: This is a major benefit for the do-it-yourself investor because not everyone has a schedule that permits trading during regular market hours. The ability to start the day early and place trades in the pre-market is a big advantage for most people due to the frenzied pace of everyday life.
• Get a jump on the competition: Astute traders and investors who are familiar with trading patterns and experienced in extended-hours trading may use the pre-market to buy or sell stocks at more favorable prices, compared to prices obtained by other traders in the regular session. This is only possible if the pre-market reaction to news about a stock is accurate, and the stock does not fully discount the news in pre-market trading. In such instances, a stock that trades higher in the pre-market will continue to trend significantly higher in the regular trading session, while a stock that trades lower in the pre-market will trend lower during regular trading.

Pre-Market Trading: Risks

We now turn to the risks of pre-market trading, which include:

• Limited liquidity and wide bid-ask spreads: The number of buyers and sellers of stocks is far fewer in the pre-market, compared with the multitudes of traders and investors during regular trading. As a result, pre-market trading volumes are generally a fraction of volumes in the regular session. Low trading volumes result in limited liquidity, greater volatility, and wide bid-ask spreads.
• Price uncertainty: Prices of stocks traded in the pre-market may diverge significantly from the prices of those stocks during regular hours. Apart from the impact on stock prices from vastly differing trading volumes in pre-market and regular sessions, pre-market stock prices may only reflect prices from a single or handful of electronic communication networks (ECNs). During regular trading hours, multiple exchanges, ECNs, and market makers provide stock prices, leading to better price discovery; the stock quotes shown are consolidated and represent the best bid and offer across all trading venues.
• Limit orders may result in non-execution: Many brokerages only accept limit orders in extended-hours trading, so as to protect investors from unexpectedly adverse prices. Limit orders can only be executed at the limit price or better. The benefit of this feature of limit orders means that the investor knows the highest price at which a stock will be bought or the lowest price at which it will be sold. But this also means that if the market moves away from the limit price, the order will not be executed.
• Competition from institutional traders: Retail traders face an uneven playing field in pre-market trading because many of the participants are institutional and professional traders who have a trading edge on account of much deeper pockets and access to better, more timely information.

These risks mean that only experienced traders should consider trading in the pre-market because the odds are stacked against retail traders. Seasoned traders have the knowledge and experience to gauge the many nuances that make trading a challenge—such as assessing whether the pre-market reaction to the news is an under-reaction or over-reaction—and taking decisive action on trading matters like opening a new stock position or closing an existing one, setting limit prices at certain levels for buys and sells, etc.