Don't Get Burned Trading After Hours

In the wild, wooly, dangerous world of after-hours trading, even iRobot's (Nasdaq: IRBT  ) friendly bots can turn into red-eyed Terminators.

The robot maker reported earnings for a pretty darn great second quarter last night. Sales ballooned 60% year over year, led by stellar demand for the government and industrial robot lines. Economies of scale kick in when a manufacturing company grows sales like that, boosting gross margins and everything below them on the income statement. In total, iRobot saw GAAP earnings explode from a $0.10-per-share loss a year ago to a $0.20-per-share gain this time around.

Based on these numbers, it's not hard to see why iRobot's stock is up a healthy 7% today. But that's only with the benefit of sleeping on the report. The stock price spiked as high as $22.41 per share overnight, for a stunning 17% increase. Sadly, that didn't last into the market's regular trading hours.

If you expected that mirage to last, you clearly haven't studied after-market moves much.

What happened?
iRobot just showed us why it's so dangerous to dabble in after-hours trading. The trading volume on iRobot after last night's closing bell was paper-thin, even for a company that doesn't attract much attention anyway. Buying or selling shares in the off-hours market under these conditions is subject to wild swings, because you might as well just go day trading on the Pink Sheets. I mean, take a look at this:

Company

3-Month Average Daily Dollar Volume

52-Week Range
(from low to high)

iRobot

$3.1 million

123%

Cell Therapeutics (Nasdaq: CTIC  )

$3.8 million

1,425%

Jamba (Nasdaq: JMBA  )

$2.0 million

290%

Microvision (Nasdaq: MVIS  )

$1.8 million

199%

Source: Google Finance.

Here be dragons
Pick one of these wildly volatile stocks, open a five-day chart from your favorite financial service, and zoom in on the volume indicator. In after-hours action, they're all deader than a doornail. There were times last night when trades of a few hundred shares -- easily within the reach of many individual investors -- moved iRobot's share price by several percentage points.

Speculators are free to run wild in a market like that, manipulating the action with a few well-placed trades, and either winning big or losing big in the process. When the morning after rolls around, and properly managed market mechanisms take over the action, prices should stabilize to sane levels. In iRobot's case, that means retreating to a much more modest earnings-related pop.

Days with significant news, such as iRobot's earnings report, will probably attract a few hungry wolves in off-market hours, even for a small and relatively unknown stock like iRobot. Just don't go there, OK?

Did we mention these were very large dragons?
Don't think you're safe just because you're dealing in large-cap stocks with heavy volume, either. Even ultravoluminous stocks that shift billions of dollars on the market every day dampen down to easily manipulated levels after the closing bell. That includes Apple and its $7.4 billion daily dollar volume, and ExxonMobil's multibillion-dollar action.

If you touch any stock at all after the market closes, be sure to have a price in mind, and stick to it with limit orders. You're treading on dangerous ground, as a handful of intrepid iRobot owners with itchy market-order fingers can attest today.

Wrapping it up
Volatility can be your friend, but only if you treat it right. Options strategies and deft buy/sell strategies can make you money from wildly swinging stocks. After-market trading is a completely different animal that plays virtually no part in a sound volatility strategy. If that's how you plan to make your money in the stock market, I wish you the best of luck. That's not investing -- it's day trading, gambling, speculation, a stab in the dark. Not Foolish at all.

Just don't do it. You can double your money on a stock like iRobot without going to risk-laden extremes like after-hours trading.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. iRobot is a Motley Fool Rule Breakers selection. Apple is a Motley Fool Stock Advisor picks. Try any of our Foolish newsletters today, free for 30 days. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (6) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 29, 2010, at 6:52 PM, mammon12 wrote:

    Just as with normal stock trading, you should stay away if you don't know anything about how it works, so it goes in the after-market.

    If you take the "sane" prices proffered during market hours as a starting point, you are already admitting that everyone else knows more than you, not necessarily a good place to start, but subsequently understandable how the market can get wildly out of whack with reality with that kind of herd mentality.

    If you are truly a fundamentalist, then limit orders in all markets at all times would seem to be in order. You know what a stock is worth so you are willing to buy it if it gets a random 10% haircut. Sometimes when you trade after hours you are moving the market and this power certainly needs to be held within knowledgeable hands. So if you have the knowledge, isn't some power better than none?

  • Report this Comment On July 29, 2010, at 6:54 PM, mammon12 wrote:

    Note: The 10% haircut comment was again assuming the market price was correct to begin with, which goes against my point that many times the liquid market is itself incorrect.

  • Report this Comment On July 29, 2010, at 9:41 PM, amatsky wrote:

    ok. novice here, sort of. Does the after hours market effect the next days trading or not? Is it a good sign to see "+" numbers after hours or does it truely not matter at all?

    It seems that it has some bearing on the next day activity but this article just left me with more questions. thanks.

  • Report this Comment On July 30, 2010, at 8:19 AM, jrusso9722 wrote:

    I'm no expert, but I don't place much importance on up or down after hours moves. As soon as the market opens, it takes off right from where the market closed the day before.

  • Report this Comment On July 30, 2010, at 11:15 AM, amatsky wrote:

    thanks

  • Report this Comment On July 30, 2010, at 12:10 PM, TMFKris wrote:

    Here is a link to the Fool's wiki entry on after-hours trading. It includes a couple of SEC links that I'm going to check out. We're building the wiki, so help on this or any other entry is welcome. Thanks!

    http://wiki.fool.com/After-hours_trading

    Kris - TMF copyeditor

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