Pre-Market Trading Activity Observations

Summary

• Access to brokers with ECN's supportive of extended hours trading has increased, contributing to more overall non-intraday trading.
• Extended hours trading is becoming as important in asset pricing as intraday trading to the price discovery.
• Pre-market trading contributed to 46% of Apple Inc. price action YoY.

If you’re active in the markets you’re probably used to reading the morning news (or your favorite SA Contributor) as you prepare for the 9:30 opening bell. You check where the Dow closed yesterday, check the pre-market price, and think about the upcoming reporting period for your own or your clients’ holdings. The notions of “pre-market” and “after-hours” trading are foreign to you. Sure, everyone knows about the market’s two phantom sessions, but “nobody trades that” you tell your clients. Afterall, you were taught that those sessions are reserved for the big boys of downtown Manhattan. Still, more and more of the people that surround you have been telling you to get in on extended hours trading. You scratch your head, staring idly at the bronze charging bull paperweight on your desk, thinking you have to be missing something.

Proliferation of ECNs

The reality is that extended-hours trading, holistically referred to as pre-market trading, is more accessible than ever, and it’s becoming noticeably significant. Long gone are the days of only paying attention to the intraday session occurring between 9:30 and 16:00 EST.

Pre-market trading used to be available to very few investors, usually only the large institutional players managing hundreds of millions in assets, exchanging large blocks of shares with equally as large participants. Now anybody can trade in the pre-market. Stock exchanges, asset managers, and banks, all rely on electronic communication networks (ECN) that make it possible to transfer information and instructions quickly between participants, and over the past decade access has become increasingly easier and cheaper. Retail/discount brokers now offer access to extended trading hours at smaller costs, Robinhood added some pre-market functionality to their free trading platform last year, and platforms like Morpher offers full pre-market trading access with no fees.

Moreover, banks and institutions are trading in pre-market more than ever before.

Measuring Price Action Contribution

With easier access to pre-market trading it is useful to examine the extent to which pre-market plays a role within the price discovery process. We measure pre-market contribution as the quotient of the absolute pre-market return, and the sum of the absolute return of pre-market and intraday session trading. This makes this test repeatable and comparable using even standard EOD data.

Examining the contribution that pre-market price action makes to total market price action reveals the following results.

In terms of absolute price changes, pre-market constitutes such a great part of the total performance of an asset that it becomes a principle of risk management to at least ensure that you have access to pre-market trading. The increased focus on systematic trading has also pushed many companies into extended trading hours; either to exploit indicative behaviour, as seen in pre-market futures, or to act on dark pool trade settlements. YoY pre-market activity is reaching its highest point in almost 10 years.

Apple Inc. (AAPL) is one of the most highly traded stocks of the S&P 500 and Nasdaq 100 indices. It is also one of the most traded stocks among retail investors. Plotted above is how much of total price action is attributable to the pre-market. The fact that almost half of Apple’s price action comes from pre-market trading makes you consider whether you’re missing out by not trading in the pre-market.

Implications of Increased Pre-Market Activity

Rising pre-market activity and ECN-broker access means that there is more liquidity within the pre-market than ever before. This naturally lends the market to a more efficient state, and leaves analysts searching for indicative behaviour.

One metric that we've observed many investors demanding is the test of indicative action. In other words, investors want to know the probability that a stock increases in pre-market and continues increasing throughout the intraday.

Well, we've observed that on an aggregate level for the S&P 500 constituents there is no correlation within a sample set of 5 years. In fact, the probabilities continue to tend to 50%.

There are certain stocks that lend themselves to more pre-market predictability. However, on a fundamental level it is difficult to establish what factors contribute to increased pre-market activity.

Factors that have come to our consideration have failed to indicate a causal actionable relationship, while still correlating well with these aforementioned results. It is difficult to determine whether these observations are a result or byproduct of retail investment activity or insider activity.

Many analysts suggest that this shift towards increased pre-market trading is indicative of the prevalence of informed trading, a result of decreased trading frictions and information costs.

Even the NASDAQ 100 Pre-Market Indicator (QMI) showcases increased volatility within pre-market - excluding after-hours.

Conclusion

With pre-market activity on the rise, in both volume and importance, it's important to determine what impact this has on retail and personal investors. Should active investors spread their focus to include pre-market and after-hours activity? Especially of interest to both academics and investors is whether extended-hours trading sessions are becoming as efficient as regular hours.

Regardless, investors need to start appreciating the gravity of extended trading hours and the impact that more participants brings on price-discovery during announcements, reporting periods, and news.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.