As the major U.S. stock exchanges prepare to embrace longer trading hours, they’re also grappling with the adoption of volatility controls that suit the distinct conditions that may prevail in overnight trading sessions.
In a filing to the U.S. Securities and Exchange Commission (SEC), the exchanges — including various subsidiaries of Nasdaq, the New York Stock Exchange and CBOE Global Markets, Inc., among others — published a joint proposal that sets temporary price band protections (market-wide up and down limits) for overnight trading, which is expected to launch by the end of the year.
These sorts of controls are designed to guard against market disruptions that are sparked by excessive volatility in securities markets due to sudden, unexpected price moves (arising from events such as a “fat-finger” trades, or “flash-crash” episodes).
“Overnight trading sessions present unique challenges for market integrity, including reduced liquidity, increased information asymmetry due to overnight news flow and global developments, and a heightened potential for erroneous trades,” the proposal said.
“Implementing the proposed market protections during overnight trading sessions should limit the frequency and severity of harmful price dislocations.”
In their proposal, the exchanges call for “a cautious approach to extending protections to the unique conditions presented by overnight markets.” Specifically, they propose a two-phase approach to setting controls, starting by adopting the current protections used by certain alternative trading systems (ATSs), and refining those measures based on data collected on the operation of these controls in overnight trading sessions, to come up with final controls.
To that end, the exchanges proposed a framework for calculating and disseminating controls to be used during overnight trading — which is defined as running from 9:00 p.m. through 4 a.m. Eastern — that would require all trading venues that operate during this period to establish and enforce policies and procedures that are designed to prevent trades outside the overnight price bands.
The overnight price bands will be calculated using two reference prices: the closing price and a post-market execution price. The use of two prices to set those bands is intended to avoid the creation of bands that are “too restrictive,” potentially hampering price discovery based on news that comes out after the close, the proposal said.
At the same time, the decision to end protected overnight sessions at 4 a.m. was made to accommodate the practice of issuers releasing earnings and making other important corporate disclosures in the hours before the traditional trading day starts — allowing market participants “to incorporate newly disclosed information into securities prices without the constraints of pricing bands based on the prior day’s activity,” the proposal said.
During the overnight session, the proposed controls aim to protect investors by preventing trades at “aberrant” prices in a trading environment when there’s less liquidity and “the risk of erroneous trades or transitory gaps in liquidity is heightened” — whereas for early market trading, “when fundamental corporate information is being disseminated and absorbed by the market, and the price discovery process will be allowed to function without impediment,” the proposal said.
In the second phase of the controls implementation, which is expected by the end of 2027, the exchanges plan to adopt more permanent requirements to govern overnight trading protections — protections that would “more closely resemble” the controls that apply during regular trading hours.
In the meantime, the exchanges have decided not to implement automatic trading pauses during overnight hours. However, the exchanges would retain the discretion to order trading halts during overnight hours.
Those kinds of halts would remain in effect throughout the trading session, since the exchanges haven’t established a process for restarting trading in overnight sessions (trading halts in normal hours are resolved with auction processes).
The proposal stressed that applying uniform protections across all trading venues in the overnight sessions will facilitate fair competition and ensure that investor protections remain consistent across all venues.
Establishing guardrails for overnight trading aims to “mitigate the risk of excessive volatility in markets and will help to prevent extreme price swings and erroneous trades, which will protect investors from excessive volatility in the new overnight trading session,” it said, enhancing confidence in the overnight trading market.