You must have heard about the Dow futures in context to the stock
market. And you are right when you heard that Dow futures have an influence on
the stock market. To know how and why, let us see it from the very beginning. A futures
contract is a legally binding agreement between two parties and as per this
agreement, both the parties agree to exchange money or assets based upon a
relationship to a predetermined price of an underlying index. In other words,
two people or two establishments agree on one single thing that if the Dow
Jones Industrial Average index is at or above a certain price by a certain
date, then one party will pay another the difference between the actual closing
price of the index and the predetermined price upon which they agreed when they
entered into the contract. This is a little different from the option contract
which gives the holder the right but not the obligation to exercise the terms
of the deal. However in case of futures contract, both parties are bound to go
by the deal. And this is all governed by the Dow. This is because Dow Futures contracts trade on an exchange which
means that the exchange serves as the counter-party of every position. This is
a more safe and secures agreement because none of the party has to worry about
the other party going bankrupt or unable to fulfill their side of the deal. The
exchange serves to guarantee every position.
Dow Futures have built-in leverage that allows
traders to make substantially more money on price fluctuations in the market
than they could by simply buying stock outright. This is because the multiplier
for the Dow Jones is 10. This means that if the Dow futures are trading at
7,000, a single futures contract would have a market value of $70,000. So, if
the Dow Jones Industrial Average fluctuates by $1, the Dow futures contract
will increase or decrease $10. Traders who have a great experience and market
insight and think that the market would perform great in the day or days to
come,they can acquire Dow futures and make a huge amount of profit as a result
of the leverage factor.
Dow Futures begin trading on the Chicago Board of
Trade at 7:20 a.m. This means that trading takes place before the actual stock
market opens and this is when the professionals get an estimate of how the market
would perform in the day. For example, if the company reports huge earnings and
the Dow futures goes up, the market is most likely to go up. Similarly, if Dow futures
are not too great due to some stock fall, the market also opens at a low note.