Premarket stock trading allows investors to trade before the stock exchanges open. Trading before the open can provide a few benefits to investors, though it presents some drawbacks too. Here’s how premarket trading works and what you need to know before using it.

How premarket trading works

As its name implies, premarket trading allows investors to buy stocks before the stock exchange officially opens. While you access the premarket from your online broker, just as you would for a regular-hours trade on the exchange, premarket trading happens via electronic communication networks, or ECNs. ECNs connect traders electronically and match the market’s best bid and ask quotes. When there’s a match, the trade executes. If there’s no match, or there are no buyers or sellers, a trade won’t happen. So a trade may take a while to execute, if it does at all.

Premarket trading can begin as early as 4 a.m. ET for stocks on either the Nasdaq or New York Stock Exchange. However, your broker may restrict its premarket hours or not offer this service at all, so you’ll have to check to see when and if you can trade.

Here are the premarket hours offered by five major brokers:

• Charles Schwab: 7 a.m. to 9:25 a.m. ET
• TD Ameritrade: 7 a.m. to 9:28 a.m. ET
• Merrill Edge: 7:30 a.m. to 9:30 a.m. ET
• Fidelity: 7 a.m. to 9:28 a.m. ET
• E-Trade: 7 a.m. to 9:30 a.m. ET

Not every broker offers premarket trading, but the largest brokers typically do. Brokers often allow you to input your premarket orders the night before, once the after-hours market closes.

In the premarket, traders don’t have the full range of order types they have in the regular market. For example, you’ll still be able to buy, sell and sell short, but many brokers don’t permit market orders and instead require that you place a limit order for any trade. Other special order types typically are not accepted. Ultimately, these restrictions help prevent traders from placing a poor trade that craters or skyrockets the stock, ensuring a more orderly and stable market.

Besides premarket trading, if investors are looking to invest outside regular market hours, they also can place orders in the after-hours market or extended-hours market. The after-hours market can start as early as 4 p.m. ET and can run as late as 8 p.m. ET on regular trading days. It has the same benefits and drawbacks of the premarket, which are detailed below.

Why trade stocks in the premarket?

Investors can trade in the premarket, but what are the advantages of doing so? There are at least three reasons investors might want to use the premarket to trade:

• You can respond to news: Most traders don’t use the premarket, so it may give you a jump on the competition, who literally may not even be awake when news breaks. Companies often issue earnings reports and other important news at 6 a.m. ET, and the premarket gives you an opportunity to trade before some investors become aware, potentially allowing you to find a better deal or sell at a higher price.

  But it’s not just news related to the company. Macroeconomic reports and data often come out before the bell, and news from international markets — how they traded and what they’re worried about, for example — is coming in all the time too.

• You can react to futures prices: Before the market officially opens, traders are pricing futures, and the premarket gives investors an opportunity to ride the trend or bet against it. If news comes out that might shift the market, you can be ready to move.

  Importantly, the price of futures contracts on an index such as the S&P 500 can diverge from the calculation of the index’s fair value. This divergence provides an opportunity for nimble traders to arbitrage the difference and make a profit.

• Greater convenience: Extended-hours trading gives investors more time to make their trades. During regular hours, you can’t always be by your computer or pull out your mobile phone, so premarket hours give you a little extra time to get your business done.

What are the downsides of premarket trading?

While those are some solid benefits, premarket trading does have downsides, though savvy investors can sidestep these issues somewhat. Potential drawbacks include the following:

• Lower liquidity: With fewer investors out there, even the largest companies may not see much trading action in the premarket, let alone the smaller companies. That means your order may not get filled, even if you do offer a much better price than others.
• Wider spreads: A less liquid market also means that the spread between what buyers are bidding and what sellers are asking is probably larger than otherwise. A larger bid-ask spread makes trading more expensive. Experienced traders may consider using limit orders to get their price instead of accepting the market price.
• Volatile prices: Another consequence of lower liquidity is that prices can be very volatile. For example, if a few investors think a company’s premarket news is bad, they may sell the stock regardless of the price they receive. That can cause a thinly traded stock to plummet on a relatively few number of shares traded. However, adept traders may be able to scoop up a bargain if they think the move is overdone.
• Unclear price discovery: Because of lower liquidity and volatile prices, the premarket can lead investors to believe a stock is going to move one way when investors in regular hours see things much differently. In the premarket, investors might dump a stock because of perceived poor earnings, leading to a 5% decline, for example. But in the regular hours, investors may trade it closer to a 1% decline or perhaps even a gain.

Bottom line

Premarket trading offers some valuable benefits to traders, though with some clear but (somewhat) manageable drawbacks. Savvy investors who know what they’re doing and have a clear idea of a stock’s value may be able to take advantage of the premarket’s lower liquidity and find a deal.

However, less experienced investors may be better served to wait until regular hours in order to avoid the risks associated with extended-hours trading. (If you’re a beginner, you’ll want to have a look at how to invest in stocks before you dig into trading.)