In the previous article, How to trade in the Premarket or Afterhours Sessions, we learned how to see what stocks were trading at before the market opened. While this gives us a good idea of how individual stocks are performing, what about the market as a whole? How do we know what to expect for the day before the opening bell sounds? In this article, I’m going to be showing you how you can look at index futures to see what direction the market will be heading to open the day.
What are index futures?
In the investing world, there is something you can purchase called a futures contract. A futures contract is a lot like an options contract in that they are priced based off of what you think will happen to the underlying security in the future. An index (Dow Jones, S&P 500, Nasdaq) futures contract, binds the parties to an agreed value for the underlying index at a specified future date. For example, the September futures contract for the current year on the Dow Jones Index reflects the expected value of that index at the close of business on the third Friday in September. In the contract, one party is long and the other short. The loser must pay the winner the difference between the agreed index futures price and the index closing value at expiration.
The trading aspect of futures contracts can get very confusing so what I want you to focus on is that the contract reflects the expected value of the index for some time in the future. Suppose some good new comes out overnight such as a positive job report, GDP report, or great international news. Investors will anticipate a stronger U.S. market and start buying up futures contracts as a result. The increase in the futures contract is roughly the same increase we will see in it’s underlying index at the opening of the market. So if the Dow Jones futures contracts are trading up 50 points right before the open, we can expect the Dow to open 50 points higher as well.
Why is it good to look at them?
In the article, What’s driving the Market’s Sleigh this Season?, I noted how look at what’s causing the market to move in a certain direction for the day. One of the first things I do when I wake up is look at the index futures contracts to see what kind of day we are looking at (up, down, flat) and then search for news to see what is driving that movement. This top down approach allows me to understand what’s going on very quickly and gives me a good indication on what will be happening with my trades that day.
So how do I look up index futures?? There are 3 different ways you can look up futures.
- Trading Platform
Sometimes your trading platform will have them preset into your trading screen such as TD’s Think or Swim.
- Financial Websites
- Manually type them in
Other times you will have to manually type in the symbol to look them up online or with your trading platform if you want to include them in your watchlist.
The futures market has employed a standardized method of abbreviating contract and their expiration date. The first two letters of a ticker symbol represent the underlying contract:
- YM=Dow Jones
- EN=S&P 500
The next letter in the ticker represents the month that the contract expires (indexes go in quarters)
The final number is representative of the year the contract expires (ie. “4” for 2014).
In other words a ticker symbol of /YMH7 is the ticker of a Dow Jones contract that expires in March 2017 (Most current)
- S&P 500= /ENH7
Little more complicated! (Luckily once you put it in your watchlist its good for 3 months)
Homework: If you have a trading platform try to find the index futures or manually type them into your watchlist. If you do not have a trading platform or cannot find them on there, then pick a financial website that you like the most to keep track.