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What Is Premarket Trading?


The term premarket trading is used quite commonly in market parlance.

In fact, premarket trends are often the backbone of active trading.

They prepare investors to watch out for the most telling market moves.

As the name Premarket indicates, this period is before the market trade opens in a full-fledged manner.

Investors often analyze the market moves in this period for a clearer market direction.

It begins at 8 am EST, about 1.5 hours before regular trading kicks off at 9:30.

Often the trends in premarket trade are the best judge of the potential market movement.

Premarket TradingThe question is when you have regular trading hours, why do you need pre-market trade?

Indeed extended trading hours have been a matter of debate for a long period.

Be it premarket trading or after hours trading, the necessity of it is constantly argued upon.

The other school of thought is why just a few hours of extended trading hours for stocks?

Many market operators believe why not extend for 24 hours like commodity or currency trade.

The question is why this set timing is so important for the stock markets?

Given the challenges of varying time zones, this is a very pertinent question for the global village.

Well, one of the most common arguments in this context is that of a weekly vegetable market.

There is a well designated time and date for this market.

It is operational only at those hours.

So, both the buyers and sellers know when to assemble in the market.

The same principle holds for stock markets.

The idea is to get as many participants as possible.

Technology has now made it possible to trade remotely.

But you still have the maximum trade executed during trading hours.

Premarket trading is a low volume affair.

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Why Introduce Premarket Trading at All?

So, it is an accepted fact that most extended trading hours are low volume hours.

The relative participation is much lesser at these hours.

The bulk of trading happens at the designated trading hours.

But pre-market trading and post-market trading is the norm in most stock markets now.

In very simple words, this can be seen as a response to advancement in technology.

The internet has shrunk the entire world into a global village.

Every country is connected with each other.

Markets too are connected.

There are some markets like the currency and the commodities market which are trading 24×7.

That is because some market in the world is open at a certain time for sure.

As a result, you can take a position in these asset classes based on it.

The fact is some stock market in the world is also open at all hours.

But unlike commodities or currencies, stocks are not centralized assets.

Every country has its own designated set of stocks.

The same company may be listed in two global exchange.

But the price mostly factors in the local price conditions and triggers.

International price movement does have some impact, but you have to see it in local perspective.

With premarket trading, investors can now look at factoring in these global developments to an extent.

But the global factors comprise of only a part of the overall triggers for the market.

You have to also take into consideration several smaller and local elements.

So the premarket trading and after hours trading is more like keeping more options available.

So if an investor is very keen to take advantage of a certain price advantage, it is an option.

But at the same time, this is not the only factor impacting stocks.

How Can Premarket Trading Help Traders?

Think about how you look for cues for stocks every morning.

Even if you are invested in the stocks for the longer term, these cues are crucial.

They give you important insight in terms of how the price movement may chart out.

While for day-traders this is crucial, even long-term investors can sometimes take advantage.

Well, in simple terms, premarket trading helps you take advantage of this very factor.

It is a type of a market cue for the traders who are following these trends.

Over the longer term, this can also act as the alert mechanism for traders.

So when you set out to chart the market movement, this gives you a price based direction.

Let’s say dollar prices saw a major swing overnight.

Now all the stocks that play on the dollar’s value will be impacted.

With the possibility of premarket trading, you can get the first mover’s advantage.

You can easily act upon the stock before rest of the market gets an opportunity.

In many ways, it gives you an edge over peers in terms of trading leverage.

It sets you up better for potential trading direction over the longer term.

So if you are a serious and a seasoned player, it is your window of opportunity.

You can easily use this low volume window to try out strategies with bigger return potential.

That will always make sure that your profitability is not compromised significantly.

It maintains even playing ground for those who are keen to take a risk in the market.

As the old saying indicates, higher risk always has better rewards prospect.

As a result, you are able to get a handle on significantly better return prospects.

A calm and poised approach will surely help you get an edge.

Tackling Economic Indicators in Premarket Trading

This is perhaps one of the select advantages of pre-market trading.

Economic indicators are seldom announced during market hours.

They are invariably released before or after a trading session.

As a result, this is one of the key developments you can take advantage of in premarket trade.

Most key data points are announced just before trade opening around 8:30 am EST.

So premarket trading gives you the most appropriate opportunity to take up a stance.

This one hour difference between data announcement and real trade starting can be crucial.

Premarket trading helps you build a position upfront.

However, you must remember that these are not everyday trades.

The price action is directly triggered by the data announced.

On such days, you can surely use this medium to kick off the trading stance.

It sets up the mood in the trading room upfront.

Depending on whether these data points satisfy expectation or better estimates, you can take a call.

The advantage is that the risk of a trade reversing is fairly limited.

For example, the Jobless Claims are announced on Fridays every week.

Supposing there is a drop in the number of jobless claims, it is good news for the economy.

Even for stock perspective, it is a positive development.

So the market reaction will be fairly predictable.

If the analysts were expecting a drop and the claims are much lower, it will be an instant fillip for indices.

Similarly, if the claims are worse than analyst expectation, it will result in the markets slipping.

Unless there are some clarifications attached to it, this kind of market reaction is predictable.

So even when volume picks up during the day, you will not see a very radical change.

The markets will move mostly on predictable lines.

Earnings Season

Most stocks declare their corporate performance every quarter.

It is normally a complete account of their profit, losses, new order win and future projections.

These are some of the biggest triggers for a stock in both the long-term and short-term.

From determining the fair price for the stock to the Houseviews, the earnings are the biggest trigger.

As a result, the market awaits these with baited breath.

There are a series of analyst estimates on these numbers.

Almost for every stock, the earnings impact the yearly price movement.

For a few major players, it can also impact the sector.

For example, if P&G sees a decline in demand for new toothpaste brands, the loser is not just P&G.

You can automatically extrapolate that buying capacity is reducing.

That means customers may not be keen about investing money in new offerings.

This will not augur well for the entire consumer product sector.

Again, on the other hand, one sector’s loss can be another sector’s gain.

Now premarket trading is one avenue to take advantage of all of these factors.

This is because a lot of companies announce their results before or after trading hours.

Let’s say stock X closed well below its 52-day moving average in anticipation of bad results.

Now the results are announced next morning in premarket trading.

The profit is actually marginally better than estimates.

This is on account of a new order win that the market did not account for.

This gives you the perfect opportunity to take a position at a much lower level.

You can easily enter the stock at significantly lower levels.

Once the market opens, the stock will respond to the positive results and move up.

When the prices rise, you can easily book profit and clock significant gains from the trade.

Limitation of Premarket Trading

The low liquidity and volume are undeniably the biggest limitation of premarket trade.

The trading activity is limited to a select number of players.

As a result, you often end up having rather large bid and ask prices.

The limited volumes are one of the most distinguishing elements of this early trade.

This is why there are many instances of retail brokers limiting the order types.

The risk is if the trade reverses in regular trade, investors can book deep losses.

This is why limiting order types are often seen as an option to limit trading volume.

Though some amount of premarket trading can begin as early as 4 am, there is a limited activity.

Only select stocks see any action.

That too, it is few and far between.

Most times, the action in premarket trading is news based.

When there are no such triggers, it is quite normal to see no action at all.

Quite understandably, the liquidity in the market is very thin as a result.

The index and ETFs benchmarked on them may see some movement.

But there is absolutely no guarantee that you will get a movement.

A few stocks and sectors which are global plays may get some attention.

So you can see the like of Technology sector or stocks like Apple recording a few ticks.

But this is never about a broad market movement in extended trading hours.

You may think that this is a great opportunity to get the advantage early on.

But that is only part of the truth.

The limited volume may seriously impact the trading trends.

As a result, the perception that you may create could be misleading.

Often the stock may reverse the trend in opening trade.

Unless you are a market expert, the risk is quite significant.

Limit Order a Necessity in Premarket Trading

Keeping in mind this cardinal limitation, a limit order is a necessity.

With just 25% of the actual trading volumes being executed, there are many risk factors.

Most times, you will notice that the spreads are very large.

Moreover, the low volume also triggers huge volatility.

Most traders, especially a new one can get confused.

The volatility may misguide them about the overall trend.

The result then is huge losses and severe damage to confidence.

The limit order, therefore, acts as a safety valve for the inexperienced traders.

They make sure that the investor gets the price that they are looking for.

It ensures that they are not trapped in the wide gap between bid-ask prices.

These gaps can be rather tricky for investors.

The loss may sometimes mount to 5% and even higher.

These are essentially some direct measures employed to keep a check on losses.

So in very simple terms, it is a ploy to restrict the trader to book further losses.

It is aimed at introducing the concept of a brake in the entire trading process.

This goes a long way in maintaining the overall balance in the market.

The traders are not unduly leveraged in this process.

The limit order also acts as a restraining order for the new players.

Sometimes they get buoyed by the euphoria in the market.

Without thinking through very deeply, they can commit large positions.

Going forward it can result in serious losses in the market.

However, with this type of limit order in place, that risk is limited.

The investor or trader has a much better grip on the overall risk associated.

Further, this also limits the overall risk associated in premarket trading.

It is one of the most reliable trading measures.

Premarket Trading Strategies

Every stock in the market will have a distinct identity.

There is always a specific way to play the stock.

Given the overall sector and pricing of the stock, you can employ the strategy.

But that holds true for the basic market trading.

Premarket trading strategies are relatively complex.

They incorporate a complicated labyrinth of probability.

Needless, to mention this also creates the necessity to formulate some basic rules.

Don’t expect these strategies to act like a magic wand.

But at the same time, they can impact trade to a large extent and in a meaningful way.

The moment the market opens, traders watch out for the price moves.

But in premarket trading, the volume is the key to many complicated concerns.

You may not be able to predict the next movement, but the broad trend is visible.

You may not be able to predict the future trend for sure.

But at the same time, it can easily help you get an idea of where trade is headed.

Depending on the overall direction of trade, you can take a call on future projections.

The premarket gap in this context is the biggest indicator of an opportunity in the market.

Conclusion

Premarket trading can be quite challenging and satisfying at the same time.

Though it is fraught with opportunity, it is not for the weak-hearted.

However, beginners in the market should avoid this concept till they are confident.

The large spreads between the bid and ask price coupled with high volatility can be intimidating.

As a result, most look for cues from premarket trading.

The idea is to get a broad view of the future stock movement.

Of course for select news event, premarket trading can be beneficial.

Be it economic data or earnings; you can get an edge through premarket trading.

But on the whole only seasoned traders may try premarket trading for best results.

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