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Wanted: A cost-benefit analysis for longer trading hours

LiveMint logoLiveMint 14-09-2017 Mobis Philipose

Some like it hot, some like it cold, some like it in the pot, nine days old. The views on extending trading hours of stock exchanges, unsurprisingly, are even more diverse than porridge preferences.

Porinju Veliyath, a well-known value investor based in Kerala, tweeted that investors need only two hours in a whole week to trade, adding there is “nothing wrong in 24x7 trading for gamblers”. On the other end of the spectrum, there are arguments that extended hours of trading are good for investors, since they can exit or even enter positions as soon as new information becomes available.

Brokers’ associations are dead set against increasing trading hours, saying it will increase costs and help large firms gain share from small and medium-sized broking firms. Then there are some harried traders, who want exchanges to at least provide a lunch break, if they decide to go ahead with longer trading hours; while some others are hoping the extension is long enough to warrant two shifts at their firms, rather than wreck their schedules.

Judging by the cascade of reactions, it’s safe to say that this is a decision that affects a vast number of people, not only in broking or trading operations, but also in ancillary industries. So the least one can ask for is a reasonable debate before the matter is settled. And whoever is pushing for longer trading hours should stand up and provide a cost-benefit analysis to justify the move.

Stock exchanges in India have the freedom to extend trading hours till 5pm, although they have stayed with the traditional 3.30pm close, because of opposition from brokers. What is the international experience, and can the learning from overseas markets help frame sound policy here?

Regular trading hours at the leading cash equities markets in the US—New York Stock Exchange (NYSE) and Nasdaq—are between 9.30am and 4pm, which are very similar to Indian market timings. In addition, these exchanges have pre-market and after hours trading sessions—in Nasdaq’s case, this takes the total trading time to as much as 16 hours between 4am and 8pm.

But here’s the nub: while these additional sessions increase the total trading time by around 150%, they add less than 2% to total volumes on these exchanges, according to a Reuters report. Put differently, the majority of traders and investors call it a day when the regular market closes at 4pm.

Venkatesh Panchapagesan, associate professor, finance and accounting at IIM Bangalore says, “The NASDAQ experience clearly shows that people don’t order their lives around trading hours set by exchanges. While there are some who trade in the after-hours session, it is clearly not the success US exchanges had hoped it would be.” In short, the message for exchanges is: people have a life beyond trading.

Panchapagesan was a visiting economist at Nasdaq during 2002-03, a few years after US trading venues aggressively pushed the after-hours trading opportunity.

Proponents of longer trading hours might respond saying no one is forced to trade all the hours the market is open and that they can choose when to call it a day, just like in the US. “Why deny the benefit of better liquidity for those who may want to trade?” they ask. The obvious counter to this is—at what cost. If, based on Nasdaq’s experience, only a small fraction of the trading community uses the after-hours trading facility, is it worth the regulatory as well as the social cost that is involved.

Considering that liquidity is very low in after-hours trading, it will provide fertile ground for manipulative activity. After all, small Indian investors are already known to be sucked in to manipulative schemes involving illiquid stocks. “It will be like opening a gambling den right in the middle of a drinking hole,” says Panchapagesan.

A US Securities and Exchange Commission study on after-hours trading in June 2000 says, “(Analysis of) quotations spreads, trading costs, and price volatility for regular session and after-hours trading in the 15 largest capitalization stocks in the Nasdaq 100 index for February 7-11, 2000 indicated that market quality deteriorated significantly after the regular session close.” The Commission regularly warns US investors about after-hours trading, and exchanges have also been asked to put out warnings about the heightened trading costs and potential risks of trading in this less liquid market. Price movements are generally exaggerated in these sessions, which isn’t surprising because liquidity dries up after the regular market closes.

Michael Barclay and Terrence Hendershott, two well-known researchers in the field of market microstructure say in a 2003 paper titled Price Discovery and Trading After Hours: “Trades after the close contribute little to the price discovery process than do trades during the pre-open, and the ratio of private to public information is lower during the post-close than at any time during the day.”

“Two of the primary functions of a market are to discover prices and provide liquidity,” they add. From the looks of it, the after-hours market in the US fails these tests.

If, instead of instituting an after-hours trading session, Indian exchanges push the closing time of the regular session to, let’s say, 5pm, it won’t be vastly beneficial either.

The current close already overlaps with the European market timings, and pushing it by a couple of hours won’t add anything to the mix. And considering that trading in most markets is U-shaped—as in the majority of trading is in the first and last hour of trading—a shift in the closing time will only result in a protracted U-shaped pattern. It can’t be expected to improve liquidity meaningfully.

Taking the close to, let’s say, 8pm, might help align with the US markets; although, it seems like a good thing for the equity markets to digest news from the US overnight, rather than reacting in knee-jerk fashion to news in an illiquid market.

Perhaps, the regulator can consider allowing longer trading hours for index derivatives, where correlations are higher with overseas markets compared to individual stocks.

All told, while longer trading hours might make sense for some markets such as currencies and commodities, where overseas markets typically drive price discovery, there is not much of a case when it comes to cash equities.

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