Trading the night away
After-hours investing is risky business. So why are brokerages pushing it?

By Paul Sloan

Bob Carpenter thought he had a sure bet. The market had just closed, but a stock he had been following, Elcom International, a software maker, was soaring after hours. Each trade that flashed across his computer screen tempted him more than the last . . . $12 . . . $15 . . . $30. Carpenter, 33, a Rhode Island disk jockey by night and stock trader by day, jumped in at $35. Convinced the stock would switch directions, he took a short position, a way of profiting when a stock falls. Elcom zoomed higher. Panicked, Carpenter pounded sell order after sell order into his keyboard until one finally went through. In 10 minutes, he lost $10,000. It was, he says, "just the worst moment of my existence."

Such anxious moments are by no means uncommon for those who have taken the leap into the emerging world of trading when Wall Street's doors are closed. Designed to let small investors do what professional money managers have done for years, the after-hours market has so far proved a daring place to try to make a buck. The image portrayed by brokerages of couples discussing an investment over dinner and then making a trade is still a long way from reality. What's really happening is risk-taking, frenetic trading, and fleecing by Wall Street sharpies in a market where the rules are still being written. As a result, the after-hours market has become grist for a debate gripping Wall Street and Washington: how the government should oversee a stock market increasingly run by computers and fueled by the Internet.

By far the biggest problem after hours is that there just aren't enough people trading yet. Despite the dangers to unsophisticated customers, online brokers such as Charles Schwab, E*Trade, and Datek Online continue to promote and expand their after-hours sessions, betting that America's enduring love affair with stocks will cause a rush of new business. After all, the Nasdaq, which has seen huge daily swings lately, continues to rack up record volume and soar to new heights.

Just last Wednesday, a record 2.2 billion shares changed hands, and average daily volume is running about 70 percent higher than a year ago. By contrast, only about 55 million shares, on average, trade after hours. That's about how many shares of a single company, Microsoft, trade on a busy day. Schwab, the No. 1 online broker, receives orders for about 2 million shares after hours, compared with 330 million during the day. "I firmly believed there would be more interest than there has been," says Laura Unger, the Securities and Exchange Commission's point person for technology and the stock market. "It could just be that the day hasn't come for it yet."

More isn't less. Lack of volume creates a key problem for the brokerages: convincing investors it's worthwhile to trade in the off hours. It's a basic principle that markets are fairer when more people are involved. When a stock is sought after by only a handful of people, it's more likely to have big swings. And that boosts the chance of a big price move in the minutes between an investor's decision to buy or sell and the actual trade. For example, on the evening of February 24, retail giant Wal-Mart jumped more than $3, to almost $48 a share, on less than 3 percent of its typical daily volume. The next day, the stock opened $3 lower on the New York Stock Exchange–right where it had left off the regular session the day before. Such discrepancies worry NYSE Chairman Richard Grasso. "It looked like Wal-Mart had lost $12 billion in market value," he says.

Price swings are compounded by the fact that the after-hours market is fragmented. That means there are several smaller markets that trade the same stocks instead of one big one. After the New York Stock Exchange sweeps the floor and the exchanges tally up their official 4 p.m. closes, electronic networks take over. These upstart networks, called ECNs (electronic communications networks), match buyers and sellers all day long. At night, they're the only game in town.

Brokerages have aligned with different ECNs to offer after-hours trading, but for now, they're not all linked. Schwab and Fidelity, for instance, send orders to a network called Redibook. Datek routes orders to Island. E*Trade has a deal with Instinet, the oldest and largest nonexchange network for trading stocks. So type in an order to sell, say, 100 shares of Microsoft through Schwab, and Datek's computers won't know you're out there. "How do you know what the best price is at 7 p.m.?" asks a Nasdaq official who requested anonymity. "You don't. Often the investors are on their own."

Night trading, like ski jumping, tends to attract thrill seekers. Frequenting the after-hours world are people like Carpenter, who says he is trying to supplement his income by trading as often as 50 times a day through his Datek account. He's part of a new breed of traders spawned by the Internet. Admittedly clueless about the companies they trade, they buy and sell ticker symbols they read about in Internet chat rooms or hear about on CNBC. "I don't know what a company does. I don't care what a company does," says 23-year-old day trader Ryan Goldstein, who trades full time from his home in Philadelphia.

"It can be quite a treacherous place," Steve Dworkin, 29, says of the after-hours market. Dworkin chases tiny movements in stocks all day long in a room full of other 20-somethings at Tradescape.com's midtown Manhattan office. Dworkin tends to play a stock after hours only when volume seems a sure bet. Even then, he says, stocks that are easy to trade one minute can be impossible to trade the next. "It's very easy to get caught holding the bag," he cautions.

News such as earnings, a merger, or even a favorable mention from an influential Wall Street analyst can ignite a stock after hours. When Dell Computer recently warned its quarterly profits would come in lower than Wall Street expected, for example, the stock came alive after hours, swinging between $34 and $41 a share. It settled at $36–about $4 below Dell's closing price in the regular session. The next day, Dell opened closer to $40, hit a high of $41, and never traded as low as it did the night before. Those who rushed to bail out of the stock in the evening might have been better off waiting. Those who bought got a good deal.

Advocates of after-hours trading like Charles Schwab, founder of the eponymous brokerage, say it's far too early to pass judgment. It's only a matter a time, they argue, before investors generate enough volume to make for a more orderly market. "It's just beginning, and it's going to get bigger," says Schwab, adding that most of his company's customers are on the West Coast and have long been asking to trade after what, for them, is a 1 p.m. close of the stock market. If an investor decides to sell shares of Intel at a certain price, he argues, "Where's the risk?"

No place like home. The risk, critics counter, is not waiting for more partici-pants. Michael Barclay, a professor at the University of Rochester's William E. Simon School of Business, studied the market with a colleague and found that customers ended up paying more per share than they would have during the day, because of a wider gap between the asking and selling price. They looked at the market in the first half of 1999, before the after-hours market was open to small investors, but Barclay says their findings still hold true. "It's nice to go to bed and know that everything's done, but it's just not a great place for retailers in the near term," he says, referring to at-home investors.

Where there's danger for some, there's opportunity for others. Bob Poole, a professional money manager who helps run $350 million for Bricoleur Capital Management in San Diego, says he loves it when small investors and symbol traders pile into a stock after hours as news flashes on CNBC. He characterizes them as sheep coming to a party full of wolves. Poole's strategy is to pounce.

He did that one night recently when news of a merger between two telecommunication companies, Alcatel and Newbridge Networks, sent Newbridge's stock up after hours. Poole determined the price for Newbridge was too high. He quickly sold the stock, getting 10 percent more than he could have the next day. "The after-hours market is no great advantage except to people like me who will trade on the other side of people who are panic sellers or panic buyers," says Poole.

Twenty-four, seven? For now, online brokerages and electronic trading networks are pushing ahead. Datek, which currently operates from 8 a.m. to 8 p.m., says that starting in July it will let customers trade stocks 20 hours a day, seven days a week through the Island network. And Instinet, which now handles all the after-hours orders for Wall Street pros, is opening an online brokerage next month that will allow small investors to trade 231/2 hours a day, with the brief downtime to ensure that the computers are running smoothly. Instinet receives the bulk of volume after hours, providing what it says will be a bigger, fairer market for small investors.

The major exchanges are taking steps, too. Nasdaq just extended its pricing system from 4 p.m. to 6:30, consolidating all the prices offered for its stocks. The NYSE, for its part, recently announced that it is creating an ECN. Both Nasdaq and the NYSE–trying to stem the loss of business–are also considering extending hours, a change that could give a huge boost to the entire after-hours market. The Big Board hasn't revealed details of what it's considering but says any move to lengthen the trading day would not occur at least until the fall. Nasdaq Chairman Frank Zarb hinted at big changes to come after hours, saying, "Based on what we and the NYSE will do," the after-hours market will improve. Look for that to happen by the end of 2001, he says.

Of course, the stock market itself could snuff out the exchanges' and ECNs' optimism virtually overnight. Interest in the market rises and falls with the performance of stocks. And the stock market hasn't had this much trouble in a long time. A handful of tech stocks is keeping the Nasdaq at lofty levels, but other major indexes are down for the year.

Any prolonged downturn would be enough to halt what little interest there is in after-hours trading, according to New York University market historian Richard Sylla. "Suppose we do get a crash or a bear market," says Sylla. "People might say, 'I'm going to go back to playing tennis or talking to the wife and kids.' " At least until the bulls start to stampede again.