Using Futures as an Indicator
By now, most people who pay attention to the financial markets realize that what happens in Asia and Europe will affect our market here in the US. How many times have we woken up in the morning to hear CNBC or Bloomberg telling us that the European markets are down 2%, that futures are pointing to a lower open, and markets are below fair value
We now live in a global economy; what happens overseas will drive our markets higher or lower depending on what occurred while we were sleeping. This causes the S&P 500 cash, Dow 30 cash, and NASDAQ 100 cash indexes to gap up or down at the US open. If you are on the right side of the market, this could be a good thing, however, most feel the pain as the bad news drives the markets lower.
The cash indexes are a current (live) representation of the stocks that are in them. The cash indexes show the current value of the index only during the NYSE trading hours (09:30 – 16:00 ET). This mean that during a 24 hour day, the cash indexes are “calculating” for 6 ½ hours of the day, or 27% of the time.
That leaves 83% of the time that the cash markets in the US are not representing what is happening around the world. This time gap is what causes our markets in the US to gap up or gap down at the open because our stocks have been traded at the exchanges around the world and have been pushed up or down during overseas markets.
The cash indexes here in the US “don’t see” that movement until the cash open in New York. This leaves the need for an indicator that tracks the markets 24 hours a day. This is where futures come in.
The index futures are a derivative of the cash index. Futures look into the future to “lock in” a future price or try and predict where something will be in the future; hence the name. Since there are futures on the cash indexes (S&P 500, Dow 30, NASDAQ 100, Russell 2000) that trade virtually 24 hours a day, we can watch the index futures to get a feel for market direction. The futures will move based off the section of the world that is open at that time. So we have to divide up the 24 hour market into time segments to help us understand who is controlling the market.
The first markets to open are the Asian markets (including Australia, and New Zealand). They will control the market from 18:00 – 03:00 ET. This is when Europe opens, and so Europe will control the market from 03:00 – 09:30 ET. Since the S&P 500, Dow 30, and NASDAQ 100 “belong” to the US, the US takes over at 09:30, however, Europe is still open and trading for the first 2 hours of our market. During the US markets, we still have European influence during our morning session. Once we get back from lunch, just the Americas are left to round out the 24 hour day. But no sooner do we close, and a new day is starting over in Asia. Talk about a busy day, and we still have to find time to eat and sleep.
The charts below are 30 minute charts of the S&P 500 futures(left) and the S&P 500 cash index (right). The Asian, European, and US markets are on the chart on the left. The futures opened and started trading higher in Asia, then began to weaken. Europe then opened and pulled the market down. The US then opened and began to retrace as Europe closed. Notice the gap in the chart on the right. Since the cash index is not calculating throughout the night, it ended the previous day, and gapped down since it did not track during the 83% of the time while it was turned off.
S&P Futures S&P Cash
Before the US cash market opened, it was known that Europe was weak and that the US would begin at lower prices. Notice the futures have no gap, and the cash does. This is what is referred to as a “gap down” at the open, yet there really was no gap based off how the futures traded. So in this case, did futures lead the cash down? Not really. If the cash index was calculating throughout the night, you would see the same pattern. Some would say that the cash (stock) was down to “reconcile” it back to the futures. Again, no, because the stock had already traded lower in the European markets.
Asia and Europe trade our stocks on their exchanges just as we trade their stocks on ours. We can buy Toyota Motor Corp (TM – Japanese), Siemens (SI – German), and Baidu (BIDU – Chinese) on our exchanges here in the US. These are foreign companies (stocks) traded on our exchanges. Likewise, our stocks trade on their exchanges. Turn on Bloomberg or CNBC early in the morning and watch the ticker of the stocks “during European trading”. Though, unless you have an account in Europe you cannot trade them, it is nice to be able to see what the stocks are doing before we get the US open. It is easier, however, to watch the index futures, and they will tell you what the majority of stocks are doing instead of each individual stock that goes across the ticker on TV.
We don’t have to trade futures to understand what the markets are doing globally. Global markets move on news and it can be seen in the advancement or the decline in the index futures as stocks trade around the world. If we are wanting to know what the market will do when it opens at 09:30 ET, the index futures are one indicator that will give use the information we need as we approach that open. Though the market never sleeps, we don’t have to stay up all night wondering where stocks will be when we start trading in New York, all we need to do is look at the index futures and they will tell us where prices will be.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.
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