Exchange traded funds, or ETFs, are pools of investments that trade like stocks. You can buy them throughout the normal trading day -- the intraday market -- and you can buy them during the extended trading hours, often called "the after-hours market," preceding and following the intraday market, but certain features of the after-hours market pose additional risks for retail investors.
A Glance Back in Time
Before computers changed the stock market, a retail investor could only buy or sell a stock through a broker, who in turn gave the order to his preferred market specialist. The investor had little freedom of choice, and it was difficult to know in advance what the stock was actually going to cost. If the broker took the time to inform you, you would discover that there were two prices for the stock: the bid price and the ask, neither one of them guaranteed to be the price you would end up paying. Trading volume was a small fraction of the volume today. The market moved slowly; your trade might not execute for minutes or even hours. In significant ways, buying an ETF in the after-hours market is like stepping back into the stock market past.
Drawbacks of the After-Hours Market
The disadvantages a retail investor faces when trading in the after-hours market is sufficiently great that the U.S. Securities and Exchange Commission has issued a paper on the subject, "After-Hours Trading: Understanding the Risks." The first risk is that you can't really tell what is going on; your broker may execute only through a particular trading platform. It may not have the best available bid and ask prices, but you won't know that because your broker may not allow you to see other prices on competing platforms. Another risk is that because trading volume is so much lower, bid and ask prices that in the intraday market typically differ by a fraction of a cent may be quite substantial. Lower trading volume also leads to greater volatility. A single large trade can momentarily tilt the market. The SEC also warns that most after-hours trading is conducted by professional traders; as a retail investor you are at a disadvantage.
One method used for risk protection in the after-hours market is limit orders. You make a limit order by setting the maximum price you are willing to pay for an ETF, or the minimum price you are willing to sell it for. Some brokers charge more for limit orders than for orders "at the market." Even with a limit order, the price you end up buying or selling an ETF for may not correspond exactly with your limit order, but it will be very close.
Another useful trading tool in the after-hours market is the stop order, sometimes called the "stop-loss" order, which gives you an idea of its intended function. While a limit sell order may execute only when the market moves sufficiently upward, a stop sell order executes if the market falls below a certain price. In a volatile market, it can limit losses, but it also has the disadvantage of selling an ETF on what may be only a momentary downturn in the volatile after-hours market.
- Ryan McVay/Photodisc/Getty Images