Dow Futures are financial futures which allow an investor to hedge with or speculate on the future value of various components of the Dow Jones Industrial Average market index. The futures instruments are derived from the Dow Jones Industrial Average is E-mini Dow Futures.
A futures contract represents a legally binding agreement between two parties to pay or receive the difference between the predicted underlying price set when entering into the contract and the actual price of the underlying when the contract expires. Index futures trade with a multiplier that inflates the value of the contract to add leverage to the trade. The multiplier for the Dow is 10.
Futures contracts are marked to market, meaning the change in value to the investor is shown in the investor’s account at the end of each trading day until expiration. If the Dow falls 100 points in one trading day, at the end of the day, $1,000 will be taken out of the futures contract purchaser’s account and placed into the seller’s account.
Because the index and the futures contract are so closely related both in price movement and value change, index futures are used to gauge the direction of the market.
Major events and breaking news can occur during this one-hour window before the stock market opens; this news usually gets priced into the futures contracts, fluctuating like a normal index. This allows investors to use the futures prices to get a generalized view of market sentiment, and may help to position certain trading strategies before equity markets open.
It is not uncommon for investing beginners to be confused when they read the newspaper or watch CNBC or Bloomberg anchors discussing the Dow Futures and the influence they would have on the direction of the stock market. If you’re perplexed by this type of futures, take a few minutes to read through this quick introduction to them to gain a better understanding of them.
These futures contracts trade on an exchange, meaning that the exchange serves as the counter-party of every position.
The Dow Futures begin trading on the Chicago Board of Trade at 7:20 a.m. Central Time (8:20 a.m. Eastern Time), which is an hour and ten minutes before the stock market opens. That allows trading to take place before the actual stock market opens so reporters and professionals can get an idea of sentiment.
That is, if a company reports huge earnings and the Dow F. skyrocket, the odds are good that the market itself will raise as well. The opposite is also true. If an event occurs before the stock market opens that causes Dow F. to plummet, then it’s a fairly good chance that stocks will fall once the opening bell rings.
Dow Futures have built-in leverage, allowing traders to make substantially more money on price fluctuations in the market than they could by simply buying stock outright. The multiplier for the Dow Jones is 10, essentially meaning that Dow F. are working on 10-1 leverage, or 1,000%.
If the Dow F. are trading at 7,000, a single futures contract would have a market value of $70,000. For every $1 (or “point” as it is known on Wall Street) the Dow Jones Industrial Average fluctuates, the Dow F. contract will increase or decrease $10.
The result is that a trader who believed the market would rally could simply acquire Dow Futures and make a huge amount of profit as a result of the leverage factor; if the market were to return to 14,000, for instance, from the current 8,000, each Dow Futures contract would gain $60,000 in value (6,000 point rise x 10 leverage factor = $60,000). It’s worth noting that the opposite can easily happen. If the market were to fall, the Dow Futures trader could lose huge sums of money.
Trading this type of futures is risky. A leverage factor of 10 is good when it works in your favor. However, you’ll owe a lot of money if you’re at the wrong end of futures contract.
The DJIA fluctuates daily based on a number of unexpected factors, such as geopolitical events, making futures a risky investment. If you’re interested in trading futures, your broker is required to give you information regarding the risks of futures and options trading.