Each morning, the US-based stock exchanges open at 9:30 a.m. Eastern Time. If you’re tracking the markets, or simply obsessed with how they move, before this time you might see reports about stock futures or “after-hours” movement. Let’s discuss what it means when you hear about stock futures and after-hours trading, and whether these trading options are useful for FIRE investors.
Stock Futures
While the stock indices themselves only change while the market is open from 9:30 – 4, stock futures still move between those hours. If you turn on financial news before 9:30, you’ll often see what appears to be a prediction of how the market will open for the day. These “predictions” for lack of a better term, are the current direction indicated by stock futures.
A “future” is not your average investment. It’s not a share of stock or an ETF that floats on an exchange. Rather, a “future” is actually a contractual arrangement in which the buyer agrees to purchase an asset at a specified time, while the seller agrees to sell that asset to the buyer at that time. And of course, the futures contract sets the price at which that exchange will take place.
A future is what’s known as a financial “derivative” because it’s not a direct trade of an asset but is a contract to make a trade at some point in the future. A stock future is simply that: a futures contract that involves the purchase and sale of a stock. For example, the Buyer agrees to purchase 100 shares of XYZ in 2 weeks at $50/share, while the Seller agrees to sell Buyer those 100 shares of XYZ in 2 weeks at that price.
There are any number of reasons why the Buyer and Seller might enter into this arrangement. Buyer might think that in 2 weeks, XYZ will be trading on the open market at $60/share, and so this arrangement would allow Buyer to purchase shares at $50 and then sell them for $10 more, netting a profit. Seller might think that XYZ will actually go down to $40/share in 2 weeks, allowing Seller to sell off the shares for a higher price than on the open market.
Alternatively, Buyer might be looking to purchase the shares in 2 weeks but wants to minimize the risk of volatility, so instead of waiting to see how the price moves, Buyer enters a futures contract so that the price is known.
Futures exist for a variety of assets. You might read about stock futures, oil futures, commodities futures, etc. Anywhere there are willing parties to a transaction of this nature, a futures contract can be executed. Because of the volume of futures contracts, they are actually standardized and traded on exchanges. In the olden days, futures trading was more common among institutional and high net worth investors, but now, as with many other financial products, retail traders are able to access futures trading through online brokers.
What does this all mean? Well, the movement of stock futures is sometimes taken as a proxy for how the market will move in the, uhhh, future. When the price of stock futures is rising during the off-hours, it’s taken to indicate that the stock market it represents will go up when the market is open. So if you look at Nasdaq futures in the morning before 9:30 a.m., and it’s showing that futures are rising, the prediction is that the Nasdaq will likewise rise when it opens.
Stock and other futures trade almost 24 hours a day, 6 days per week, meaning that stock futures move based on information released when the markets themselves are closed. If a major player on the Dow issues a press release at 5 p.m. that it’s going bankrupt, that news is unable to impact the stock price immediately because the market is closed. But it will impact stock futures that are actively being traded. In that case, the price of stock futures in the soon-to-be-bankrupt company are more than likely going to decline, which is reflective of the fact that the stock itself will likely decline the following day when the Dow opens.
If you check the stock futures in the morning before the market opens, you’ll see (often in small print) exactly which futures contracts are being quoted. But the general sense is that at a given moment, the futures are predicting how the market will move. They’re certainly not always accurate, but generally speaking, that’s what they are and that’s how to interpret them.
You can also trade stock futures. They’re theoretically no more risky than trading market-tracking ETFs, but in practice their outlook focuses more on the short-term, which can entail greater risk than a long-term approach to market-tracking ETFs and mutual funds. For the FIRE investor, there’s really no need to get into derivative trading unless you’re simply looking for something new. Buying and holding ETFs and a diversified bunch of individual stocks will get you to where you want to be.
After-Hours Trading
Related but not the same as stock futures is after-hours trading. If you read financial news in the late afternoon or early evening, you’ll probably come across headlines about which stocks are moving after-hours. And, if you look up the prices of individual shares, you’ll see a point where the market closed and then a trailing line showing the price moves in the after-hours session.
Although the markets are closed, there are ways to buy and sell stocks during the off-hours. The first is the post-trading session, which takes place between 4:00 p.m. and 8:00 p.m., and after that is the pre-trading session, the start of which varies by the market but ends when the market opens the following morning at 9:30 a.m.
After-hours trading used to be reserved for institutional investors and high net-worth individuals, but, like many other trading vehicles, has now opened to retail traders through online brokers. After-hours trading, like stock futures, is unique in that share prices can react to news that comes out after the market closes or before it opens. And, after-hours trading can indicate the direction that the stock price might head the following day, although with individual shares it’s not always a reliable indicator due to their volatility.
While after-hours trading would seem to open up the world of stock trading during the evening, be aware that it’s not a substitute for buying or selling shares during the normal market hours. After-hours trading occurs through specially managed electronic exchanges and with much less liquidity than during market hours. As a result, the bid/ask spread can impact the price at which you purchase or sell a share.
For example, if you go to buy a share of Google during the day, you’ll see a price, place an order, and it’ll likely clear in a fraction of a second. The difference in price between what you saw quoted and the amount at which the trade executed was probably minimal because there were so many sellers in the market willing to sell at the price you saw.
However, if you try to make that same purchase during after-hours trading, the situation may be a little different. You might see a price for Google at $100, approximately reflecting the last few trades between buyers and sellers that cleared on the exchange. So you place a market order to fill one share of Google at the market price. However, there may no longer be anyone willing to sell at $100. The exchange may not execute the trade until it finds a willing seller, at which point that seller might only be willing to sell a share at $102. During the day, it’s safe to assume that the purchase of a major stock will clear at just about the price you’re seeing, but this is not the case during the after-hours sessions. The same is true when you try to sell a share. The exchange may not execute a sale at the market rate until it finds a willing buyer, at which point you might get less than you expected.
For the FIRE Investor
Stock futures and after-hours trading are methods that active traders use to continue trading when the US markets are closed. My goal in explaining them here, however, is not to say that they’re a particularly useful tool for a FIRE investor. Rather, my goal is to explain what they are and why you see these numbers reported in the morning and afternoon if you’re following the stock market.
Although traders use stock futures and after-hours trading, both are more suited to the realm of active traders, meaning that there’s little need for buy-and-hold long-term investors to start trading shares in the after-hours markets. If you’re primarily buying ETFs, mutual funds, and a mix of single shares, the liquidity of the open markets should be more than sufficient for your trading needs.
After-hours markets present unnecessary risks that are not necessary to assume for a long-term investor. After-hours markets and stock futures are better suited to short-term investors seeking to capture short-term movements in response to news, or for institutional investors who are doing…whatever it is they’re looking to do by trading around the clock. But if you’re only buying shares once every two weeks when you set aside some money from your paycheck, the open market is really the place to do it. Speculating on futures and trying to capture an incremental gain after-hours is unlikely to achieve better results in the long-run than simply buying and holding.
When you open your stock app in the morning, or head to the financial page, or whatever you do to follow the market, now you know what you’re seeing when they’re discussing stock futures or overnight movement. Yes – the market works at night; but don’t feel like you’re missing out on anything other than risk that a long-term investor doesn’t necessarily need.
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