On most weekday mornings over the past year, Paris-based financial trader David Sibi has turned on a computer program designed to try and beat the U.S. stock market before it even opens.
Scouring multiple trading venues that offer U.S. shares, albeit with some restrictions, before the official opening of the New York Stock Exchange and the NASDAQ at 9.30 a.m., the program uses a combination of news and market analysis to work out which shares to buy before selling them at the open.
Sibi, 37, head of Arbitrage Technology, is one of a limited number of traders focused on the pre-market - a risky, volatile, thinly traded world mostly populated by hedge funds and broker-dealers willing to stomach potentially painful price swings.
But it is a world that also offers the chance of richer pickings than the regular trading day, which is seen to be dominated by high-speed electronic traders who can outrun slower rivals and where long-term volatility is low, limiting profits.
"Regular trading has become very difficult," said Sibi, in a telephone interview. "But in the pre-market, you are in another world...You're not up against the same people. You are no longer just prey to high-frequency traders as you usually are. You're on an equal level."
The pre-market, particularly for U.S. stocks, has for some become a refuge - despite the risk of losses - from high-speed traders that depend on a reliable flow of orders to be cost-effective. The chance to analyze data and information without the need for speed is worth the extra risk, according to Sibi.
The risks of pre-market trading have caught the eye of regulators such as the U.S. Securities and Exchange Commission, which publishes guidelines on how to trade out of regular hours.
While regulators are not investigating pre-market trading specifically, a recent batch of enforcement actions against other opaque trading practices such as the use of dark pools run by big global banks - coupled with incoming rules in Europe that aim to make markets more transparent - have also alerted investors to the risks of trading in the murkier areas of the market.
Pre-market off-exchange trading also exists in Europe but it is much less electronic than in the U.S. and requires an investment bank or market-maker to quote prices. Asia is the least developed in terms of electronic trading and investors rely more on exchanges, which do not have pre-market sessions for regular shares.
HUNTING GROUND
Other hedge-fund investors echoed the view that the pre-market was a valuable hunting ground for strategies driven by data and research.
"It is understandable that trading in the pre-market is seen as offering more opportunity and more chance to gain an edge based on information or data rather than speed," said Jasvir Biriah, managing partner at hedge fund London-based Premaeus Investments.
"However, it also carries more risk, with spreads being larger and volume and liquidity being less than regular market hours. Our strategies allow us to use a blend of pre-market and regular trading but it tends to be driven by the client's appetite for risk."
Data from U.S. broker TradeStation shows that pre-market trading as a proportion of the regular day's trading volume has risen slightly over the past few years, though it is still only 0.4 percent on average of overall volumes of the NYSE and 0.7 percent for the NASDAQ. Volumes are still well below their 2007 peaks.
"Even though this volume has grown, it's still so small," said Stanley Dash, VP at TradeStation. "I do think that it may be indicative of a certain amount of positioning by institutions...And there is more pre-market liquidity and trading in NYSE big caps than there was even a few years ago."
Pre-market trading can often spike on results: U.S. retailer Kate Spade & Co's (KATE.N) shares rose more than 6 percent in heavy pre-market trading last Tuesday after it released earnings. However, the company warned after market open that gross margins were being hit by intense competition, which sent its shares down 30 percent in record volumes.
"MUG'S GAME"
Behind some of the hedge funds and traders willing to take bigger risks in the pre-market are the brokers and banks willing to facilitate their trades - and potentially lose money.
Big banks have since the financial crisis become jumpier about incurring losses and about using their balance sheet for trading but some London-based bankers admitted the pre-market was a source of business with valuable clients and that they were open to wading into riskier waters to secure commissions.
"The pre-market is a bit of a mug's game," said one equities banker, on condition of anonymity. "But it's a question of getting the wheels turning before the market opens so that the flow comes back to us during the day. The aim is not to lose too much money."
Other traders at European hedge funds and brokers said that banks had generally cut back on activities such as market-making but that it was still possible to trade large blocks of shares with them over the counter ahead of the open.
The lack of clear information flow meant that some banks lost money because they were either less well-informed than the hedge funds trading in the stock or under pressure to strike a deal even if the price was not ideal, several traders said.
Given these risks, it will be a long while before out-of-hours trading carries the same kind of legitimacy as regular intraday trading. But for now, a select group of investors and brokers are willing to take potential losses as they search for wrinkles in an increasingly smoothed market environment.
"Generally speaking, it's a completely different market before 9.30 a.m.," said Jeffrey Bacidore, head of algorithmic trading at ITG. "Spreads are wider and markets are a lot more volatile."
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