Pre-Market Trading (Definition, Example) | Advantages & Disadvantages

What is Pre-Market Trading?

The Pre-market trading is the trading in the stock market which occurs before the opening of the regular market session (usually 1 to 1.5 hours before the market opens). Apart from the trading in the market, pre-market trading activities are watched by many of the investors and traders for the purpose of judging the strength and the direction of the market so that regular trading session could be anticipated. Many investors like to do trading in pre-market session because they want to take advantage in the competition by quickly reacting to the news announcements which occur during the time when the regular market for trading is closed.

Example of Pre-Market Trading

Company XYZ Ltd. released its earnings report for the quarter before the market opens for regular trading. The results of the company missed the expectations of the investors which are prevailing in the market for the stock of the company. Mr. A, who has a good amount of holding in the company XYZ, also has access to trade during the pre-market trading hours.

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Declaration of the earnings of the company causes the substantial movement in the prices of the underlying stocks and the largest reaction occurs typically when the company substantially misses the expectations or substantially exceeds the expectations of the investors. In the present case, expectations of the investors are missed so it is probable that the price of the stock will decrease. Now, Mr. A is having access to trade before the market gets open, so this will allow him to react quickly to the initial reaction i.e., negative news about the company’s earning and Mr. A will sell the shares during the pre-market trading hours to save his investment.

Advantages of Pre-Market Trading

Some of the advantages are as follows:

With its help, one can get early access to the market and trade according to the news which got released when the market was closed as some of the important news and announcements are there which are reported after the regular trading hours of the market or over weekends causing the potential massive movements in the market. Like natural disasters are the unexpected events which can occur anytime. If the person is having the early access of the market before the market gets open i.e., during the pre-market trading hours, then it allows him to hedge himself against the risk caused because of such unforeseeable events.
By watching the activities during the pre-market trading, many of the investors and traders can judge the strength and the direction of the market so that regular trading session could be anticipated in advance.

Disadvantages

During the regular trading hours, most of the stocks can be trade readily and easily by the buyers and the sellers with one another in the market, whereas during the pre-market trading hours, trading volume of many of the stocks is less which makes it more difficult for the buyers and the sellers to execute some trade orders.
As there are less trading activities during the pre-market trading hours, spreads are wider between the bid prices and the ask prices which makes it more difficult for the buyers and the sellers to execute their orders or to get the favorable prices for the orders which are possible during the regular hours of the market.
As there are limited trading activities during the pre-market trading hours, it is common that there will be great fluctuations in the prices in the market than the fluctuations which are present during the regular hours of the market.
Many of the persons who trade in the market during the pre-market trading hours are professionals with large institutions like mutual funds. These persons generally have access to more information when compared with individual investors. This gives an extra advantage to those professionals who work with the large institutions which the individual investors cannot get.
Many of the electronic trading systems accept only the limit orders currently in pre-market sessions. This limit orders may lead some of the investors to miss out the trade which is filled by them.

Important Points of Pre-Market Trading

There is large bid-ask spread during the pre-market trading hours because during that period there is limited liquidity and volume. This makes it more difficult for the buyers and the sellers to execute their orders or to get favorable prices for the orders.
It is offered by many of the brokers but the types of order which can be used are limited during that period.
During the pre-market trading hours, the trading activities are limited, so it is common that there will be great fluctuations in the prices in the market.

Conclusion

Pre-market trading provides the opportunity to the investors to trade in the shares before the opening of the regular market session. Generally, activities in the market are very less unless some news is there. With this, one can get early access to the market and trade according to the news which got released during the hours when the market was closed. There is large big-ask spread during the pre-market trading hours because during that period there is limited liquidity and volume. It is offered by many of the brokers but the types of order which can be used during pre-market trading hours are limited during that period.