Why futures?

Hello everybody!

I feel a little ‘silly’ asking this question now (after trading these things live for six months and being such a s**t pile down although FINALLY now clawing my way up):

Why do we have Dow Futures / DAX Futures / S&P Futures / Nasdaq Futures (you get the picture)? I mean to say - we have the Dow, the DAX, the S&P, and the Nasdaq - so why do we have two ‘options’ as it were for the same Index AND why does the ‘proper’ Index open and close with the NYSE and the futures Indexes stay open 24 hours (with the exception of the DAX)?

Regards,

Dale.

Stock index futures were created to allow fund managers and the like to have an instrument by which they can hedge their portfolios. That’s why size of the full contracts is so big ($250 x the index for the S&P). E-Mini’s were later introduced to encourage and allow smaller traders to get involved as speculators, which helps to increase the overall liquidy of the market.

As to why the proper index opens and closes with the market hours, it’s because the actual index is based on the value of the stocks which comprise it. It doesn’t not trade in its own right. In theory you could calculation the value of an index “overnight” by tracking the changes in the underlying stocks in overnight trading, but the vast majority of the action is during market hours.

Hi John - and thanks for the answer.

I’m still have a dilemma though when it comes to the underlying stocks as they relate to these indices (we have had this discussion before I know. I still haven’t got it though).

The market has just closed and I have watched all of them (the indices) drop through the floor today. What I don’t understand is when I am selling DAX for example - what am I actually selling? I can’t be selling shares in the individual companies that make up the DAX 30 for example because I did not own any (or could I indeed indirectly be selling shares in the individual companies that make up the index?) yet on the other hand the index moves based on the underlying stocks. This is messing up my brain! What I CAN understand is let’s say for the sake of argument I owned shares in every single one of the DAX 30 companies and then I decided to sell off those shares - this would affect the index - that makes sense. What I CAN’T understand is by my selling off DAX how can I be affecting the underlying stocks (or am I not)?

Which brings me to another mind bender: would there ever be a time when a) there is divergence between the index and the underlying stocks and b) there is divergence between the main index and the futures index i.e. would there / could there ever be divergence between the Xetra DAX and the DAX 30?

Regards,

Dale.

The futures are a contract to exchange the value of the index at some time in the future - not the actual index, just the value of it. When you go short the DAX futures (you really shouldn’t think of trading futures as buying and selling so much as going long or short because futures are not an asset, but rather an agreement) you are not directly transacting in the stocks which comprise the index, but you are indirectly doing so. The how so is tied in with the second part of your question.

Divergences between the “cash” index and the futures will be small and fleeting because arbitraguers will keep the two in line. They will do so by taking one position in the futures and an opposing position in the stocks when they see pricing discrepencies. In that way, action in the futures will always pass through into the cash index and vice versa.

Hi John - and - once again - thank you for your reply (I’m ALMOST getting it I think).

I wanted to add the following to my message last night before you replied so I hope you have another look at this thread:

A ‘key’ closing level for the S&P 500 was around 1540/1541 yesterday (which is pretty much where it closed on Friday thank goodness. EDIT: Actually I was wrong in this statement - the actual index closed below 1540 - only the futures index closed above 1540 - so I’m figuring it will trade south to at least its daily pivot of Friday on Monday - with my luck it will trade to R3). Again - this just adds to my confusion! What I am saying is this: if the index in based on the value / movement etc. etc. of the underlying stocks then how is is possible to even have or look at ‘key’ levels in the index? In other words - for an index to close at a certain ‘key’ level the average change for all of the underlying stocks has to result in that exact amount of change (I hope that makes sense). So - in other words - let’s take the DAX 30 (futures). Let’s say that you find and plot the daily pivot levels on the new days’ chart. It is very plain to see (especially with the DAX and the DOW) that they (almost) always hit their daily pivot level and then reverse / retract and trade to either R1/R2 (and when I’m having a bad day to R3) or S1/S2 (and again - always when I’m having a bad day - to S3)! Now if the index is based on the underlying stocks it is my understanding that the net change in the stocks of all 30 companies that make up the DAX 30 ALSO have to be trading between their respective pivot levels. Is this possible? 30 different stocks ALSO trading between their respective pivot levels that day? Again - is this possible? Is it not against the odds? I mean - if I’m getting this (which I’m pretty sure I’m not) - with the S&P 500 - overall - the stocks of 500 different companies have to be trading between their respective pivot levels that day in order for the index to reach its key levels that day?

Sorry - I know that I’m banging on about this (and acting blonde - no offense meant to anyone - I’m blonde) - but I REALLY want to understand how this works. I mean - it’s not affecting my trading - I just REALLY want to understand HOW and WHY - I have that kind of mind!

And by the way - I notice that there is a Nasdaq 100 Trust (never seen this before). From what I have read it does not move exactly in tandem with the Nasdaq 100 i.e. it moves / responds slower and is being constantly rebalanced by someone (probably by one of those ‘arbitraguers’ that you mention). Is that the same thing as the difference between the DAX and the DAX 30 for example? Also - in the case of the DAX - you have an extra hour every night and every morning to trade the DAX 30 i.e. before the actual DAX opens for trading (same with all of the indices and futures except that the US futures indices trade 24 hours). Is there anything in the difference between these trading times that you should be monitoring for the next session? Does the change in the futures index mean anything to the actual index when it opens?

And - now that I am typing this message - I just had another thought. If I understand (at least part of this) correctly - then if you are trading the DAX futures for example - should you then not rather be tracking the DAX itself in making trading decisions on the futures index? In other words - the DAX itself should be the first to respond not so?

And another thing: you will also notice that the European indices (again almost 99% of the time) follow the movement of the DOW, S&P, and Nasdaq. Why is THIS? I mean - the same companies that make up the US indices ARE NOT the same companies that make up the European indices (bar one or two of the big ones that have dual listings). Is this just due to sentiment or is there some underlying technical reason for this?

AND MORE: I also noticed yesterday that as the US indices fluctuated - so did the value of ???/USD or USD/???. At some point yesterday there was huge move on anything USD and at the exact same point there was a huge spike in Gold, Silver, Oil, and the indices. And - the best part - there was no news release or anything of the kind. Does this mean anything? Which ‘spiked’ first - the indices - or forex - and why (the only thing that I know of was the expiration of the July oil contract but that only came later in the day) (I’m not even sure I know what that means but again - its got something to do with futures I know i.e. oil futures)?

AND YET ANOTHER EDIT (HOPE YOU HAVE NOT READ THIS YET JOHN):

An even more perplexing question (for me anyway): is technical analysis of these indices worth anything at all? I don’t know why but it just ocurred to me that the movements / values of these indices are supposed to be based on the movements / values of the underlying stocks and the chances of the cumulative profits / losses / values being exactly equal to some or the other fibo level or pivot point for the index are not, in my opinion, very good AND YET having said that - they definitely trade to these points most of the time. How is this possible?

Whew - there’s a lot of stuff here - I hope you check this thread again (actually - I hope you don’t mind - I’m going to PM you to make sure - I respect and value the time you take to answer my questions - as does everyone else on the forum).

Regards,

Dale.

You have to keep in mind that an index is an aggregate of the stocks which comprise it and that in most cases there are differences in how much one stock’s price moves influence the index vs another. The S&P, for example, is a market value weighted index. That means the stocks with the largest market cap are going to have more influence on index changes than the stocks with the smallest market cap. You need to know how an index is calculated to understand the impact of prices changes in its constituent stocks will impact it.

As to the idea of key levels, while it may seem strange to think that a calculated index has significant levels, the mechanics of the market are such that they do. Firstly, becuase indices can be traded in their own right via futures, ETFs, and options levels do have meaning. Secondly, if people think a market level is significant then they will buy or sell the stocks underlying the index, forcing the index to move.

And by the way - I notice that there is a Nasdaq 100 Trust (never seen this before). From what I have read it does not move exactly in tandem with the Nasdaq 100 i.e. it moves / responds slower and is being constantly rebalanced by someone (probably by one of those ‘arbitraguers’ that you mention). Is that the same thing as the difference between the DAX and the DAX 30 for example?

That trust is an EFT - the QQQs. It is rebalanced by those who manage it (not the arbs) to ensure that it matches the performance of the the index. It is not the same as a futures contract. An ETF is actually ownership in a porfolio, whereas a futures contract is an agreement to exchange assets in the future.

Also - in the case of the DAX - you have an extra hour every night and every morning to trade the DAX 30 i.e. before the actual DAX opens for trading (same with all of the indices and futures except that the US futures indices trade 24 hours). Is there anything in the difference between these trading times that you should be monitoring for the next session? Does the change in the futures index mean anything to the actual index when it opens?

Yes, the value of the futures are an indicator of where the market will open. If the DAX futures are up 100 points before the stock market opens, then it probably means a big pop when it does open. Why? Because the DAX futures allow people to react more quickly to news and events that happen outside normal market hours. That action will translate through in to the stocks (and thereby the index) once trading starts.

And - now that I am typing this message - I just had another thought. If I understand (at least part of this) correctly - then if you are trading the DAX futures for example - should you then not rather be tracking the DAX itself in making trading decisions on the futures index? In other words - the DAX itself should be the first to respond not so?

The futures will probably react first to events because it’s easier to trade a futures contract (1 transaction) than to trade the index, which would mean trading all or at least many of the component stocks. When things are more stock-specific, though, then the index will probably move first with the futures lagging a little.

And another thing: you will also notice that the European indices (again almost 99% of the time) follow the movement of the DOW, S&P, and Nasdaq. Why is THIS? I mean - the same companies that make up the US indices ARE NOT the same companies that make up the European indices (bar one or two of the big ones that have dual listings). Is this just due to sentiment or is there some underlying technical reason for this?

The markets are very global and macro things that impact one market tend to impact the others as well.

AND MORE: I also noticed yesterday that as the US indices fluctuated - so did the value of ???/USD or USD/???. At some point yesterday there was huge move on anything USD and at the exact same point there was a huge spike in Gold, Silver, Oil, and the indices. And - the best part - there was no news release or anything of the kind. Does this mean anything? Which ‘spiked’ first - the indices - or forex - and why (the only thing that I know of was the expiration of the July oil contract but that only came later in the day) (I’m not even sure I know what that means but again - its got something to do with futures I know i.e. oil futures)?

There was a lot of different stuff flying around the markets on Friday in the form of rumors, options expiration, earnings, and a whole slew of other stuff. It was pretty crazy.

An even more perplexing question (for me anyway): is technical analysis of these indices worth anything at all? I don’t know why but it just ocurred to me that the movements / values of these indices are supposed to be based on the movements / values of the underlying stocks and the chances of the cumulative profits / losses / values being exactly equal to some or the other fibo level or pivot point for the index are not, in my opinion, very good AND YET having said that - they definitely trade to these points most of the time. How is this possible?

As I’ve noted at several points, because the indices are tradable in their own right, then analyzing them directly is worthwhile. Even if they weren’t traded, as in the old days, it would still be worth the effort to analyze them. As I noted earlier - and you brought up as well - there is the sentiment value of an index which can influence the trading in the shares which underly it.

John - thank you very much for sharing that insight and knowledge (you should be offering ‘mentorships’ - for a fee of course)!

After reading and re-reading this thread and your responses one thing has become very clear: I finally understand what Bill Williams refers to as ‘Chaos Theory’ i.e. in a seemingly random market there is an underlying order. It amazes me that the indices (for example) that are made up of hundreds of different components (stocks) as well as each of those underlying components (stocks) trade to certain key levels almost every day. One would think (as I did) that the chances of the aggregate movement in price of 500 different stocks actually trading to predictable levels on a daily basis - be it pivots, fibo, fractals, support and resistance, or whatever - was impossible but I guess the indices are proof enough that this actually really does happen.

Once again - thanks for your input and taking the time to reply to this rather long list of questions.

Regards,

Dale.

I’ve been known to, when I have the free time, which isn’t very often.