Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Late-Day Trading

What it is:

Late-day trading is the practice of illicitly recording trades executed after hours as having occurred prior to the end of market trading.

How it works (Example):

A mutual fund's net asset value (NAV) reflects the value recorded at the close of a given trading day (4 p.m. Eastern). Hedge funds frequently purchase mutual fund units as part of after-hours trading. In certain cases, these hedge funds collude with mutual fund managers who allow them (usually for an undisclosed fee) to record these buy trades as having occurred during regular trading hours, just prior to 4 p.m. This late-day trading places upward pressure on a mutual fund's published NAV and gives the hedge funds a better price. The following day, a mutual fund's NAV corrects itself to account for late-day trades. Hedge funds then profit by selling their units at this higher price.

For example, suppose that hedge fund ABC purchases units of mutual fund XYZ after 4 p.m. on Monday at the closing price of $3,000 per unit. Mutual fund XYZ agrees to record these trades as having occurred prior to 4 p.m.. Hedge fund ABC's late-day trading increases mutual fund XYZ's NAV to $3,200 per unit. At the start of trading Tuesday morning, mutual fund XYZ opens at $3,200 per unit instead of $3,000. Hedge fund ABC then sells the units it purchased the night before and makes a profit of $200 per share ($3,200 at opening less the $3,000 paid the previous day).

Why it Matters:

After-hours trading is an acceptable practice because it does not affect a mutual fund's closing price. However, late-day trading is considered unethical and even illegal because it allows a privileged few to benefit from asymmetrical price information.