1. Market Strength: Introduction
  2. Market Strength: S&P 500 Futures
  3. Market Strength: Advancers to Decliners
  4. Market Strength: Relative Strength Index and Arms
  5. Market Strength: Oil and Bonds
  6. Market Strength: Conclusion


If you've ever watched financial television before or after the markets open you will probably notice that they often quote the latest index futures price on the "bug" in the bottom corner. The futures market is an important concept and can be used to gauge the trend of the market.

Futures
There are two types of futures contracts, financial and commodities. No matter which type of contract you buy the basic premise is the same. The buyer of the contract agrees to deliver the product (or cash for financial futures) at the contract price on the expiry date. A contract can be on anything from corn, wheat, oil or, in our case, a stock index. It should be noted that a majority of futures contracts get "closed out" before the delivery date and so no physical delivery actually takes place.

The Standard and Poor's 500 index (S&P 500) contains many of the largest companies in the world, so it only makes sense that movement in the direction of the S&P futures is one of the best indicators of overall short-term market direction (Note: The Nasdaq futures are considered a good indicator of technology stocks). The word futures might make this indicator sound confusing but it really isn't. If S&P futures are up, it's an indication that there is upward pressure on the market and the stock market will tend to rise. On the other hand, if S&P futures are down, it's a sign that there is downward pressure on the market and it will likely trend lower.

This rise or decline in the futures contract is usually calculated as a change from fair value. Fair value is the equilibrium price for a futures contract. This is equal to the spot price after taking into account compounded interest and dividends lost because the investor owns the futures contract rather than the physical stocks. This price is determined over the period of the futures contract.

Arbitrageurs
Part of the reason that the markets follow the trend of futures contracts is because of arbitrageurs. An arbitrageur is someone who simultaneously purchases and sells a security (or index) in order to profit from a differential in the price, usually on different exchanges or marketplaces. For S&P futures contracts here is what happens: Suppose the futures contract is trading above fair value (higher), before the market is about to open. An arbitrageur will sell (short) the S&P futures contract and go long (buy) on the underlying stocks within the S&P 500 index. Therefore, the stock prices will increase until the S&P 500 index reaches fair value with S&P futures contract. This sounds like a lot of work but really isn't because of program trading. Using software that monitors both a stock index and futures contracts on the index, traders can be notified when there is a larger than normal gap. This strategy is commonly referred to as index arbitrage.

Popularity
The main reason that S&P futures are so popular for detecting strength is because this contract trades 24 hours a day on financial exchanges around the world. It allows traders and brokers to gauge the futures level before the actual stock markets open for trading which gives a sense of where the market is likely trend at the start of trading.

Market Strength: Advancers to Decliners

Related Articles
  1. Markets

    Using Index Futures To Predict The Future

    Want to know whether the stock market will open up or down? Check out the index futures.
  2. Investing

    Options on Futures

    Options on futures contracts offer another way for day traders to use options. These are traded on the same exchange as the underlying futures contract. Traders should take care to understand ...
  3. Trading

    Advantages Of Trading Futures Over Stocks (APPL)

    We look at the top eight advantages of trading futures over stocks.
  4. ETFs & Mutual Funds

    Introduction To Currency Futures

    The forex market is not the only way for investors and traders to participate in foreign exchange.
  5. Markets

    Crude Oil Prices: Comparing Future Price Vs. Current Market Price

    Discover the differences between oil futures market prices and oil spot market prices and what leads to the differences between the two.
  6. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  7. Trading

    Options On Futures: A World Of Potential Profit

    There's one simple hurdle in the transition from stock to futures options: learning about product specifications.
  8. Trading

    How to Trade Dow Jones Future Contracts

    Learn about the Dow Jones Index futures contracts available and obtain step-by-step instruction on how to trade the stock index futures.
  9. Markets

    How to Trade Futures Contracts

    Futures is short for Futures Contracts, which are contracts between a buyer and seller of an asset who agree to exchange goods and money at a future date, but at a price and quantity determined ...
  10. Trading

    Futures, Derivatives and Liquidity: More or Less Risky?

    Futures and derivatives get a bad rap after the 2008 financial crisis, but these instruments are meant to mitigate market risk.
Trading Center