DEFINITION:
Dow Futures are contracts for buying or selling commodities at a set price on a future date. They help investors estimate or think about how stocks might be valued before the stock market opens.
Key Takeaways
The Dow Jones Industrial Average (DJIA) and the Standard & Poor's (S&P) 500 indexes include trading for commodities. Here, you can trade contracts for future commodities on the index instead of buying stocks.
If you're new to futures trading, Dow Futures might seem confusing initially. To make it clearer, here are some basic things to understand.
Alternate Name:Dow Jones Futures
To understand how Dow Futures work, imagine a grocer and a farmer. The grocer knows the farmer will harvest soybeans soon, so they offer to buy 100 bushels in January for ₹900.
If the farmer agrees, it's a deal, and both wait for January. Regardless of soybean prices then, the grocer pays the agreed price.
A futures contract is a promise between two parties (like people or companies). They agree to trade money or things based on expected prices of an index.
Futures are different from futures options. Options come from the futures market but have their own market and exchange. When you buy options, you get the right (but not the duty) to follow through with the terms of the commodities deal. In a futures contract, both sides must do what they agreed upon.
Your trade's position is the price you agreed on with the seller. Dow Futures contracts trade on an exchange, which is the one you work with to create your position (your price and contract) on the commodity.
This exchange is there to ensure fair trading and remove risks like one party not keeping their side of the deal. When all futures contracts go through the exchange, it gets rid of this risk because the exchange guarantees every position.
Dow Futures begin trading daily at the Chicago Board of Trade (CBOT) at 7:20 a.m. Central Time (8:20 a.m. Eastern Time), an hour and ten minutes before the stock market starts. This early start lets trading happen so that reporters and experts can understand how investors feel about prices and the market's potential.
Market sentiment can be unpredictable. For instance, if a company reports big profits and Dow Futures rise, it's likely that the stock market will go up too. But if there's an unexpected event like severe weather closing shipping lanes before the stock market opens, Dow Futures might fall. This makes investors worry about potential issues, which could lead to stocks dropping when the market opens.
Dow Futures come with leverage, letting traders use less money for trading futures while getting bigger gains or losses. It helps traders potentially make more money on market price changes compared to buying stocks directly.
The Dow Jones futures have a 10-to-1 leverage, also called 1,000% leverage. For instance, if the Dow Futures are at 6,000, one futures contract would be worth ₹60,000. With each ₹1 change in the DJIA (or "point"), the value of one Dow Futures contract changes by ₹10.
Therefore, if a trader thinks the market will rise, they can buy Dow Futures with a smaller investment and potentially make a large profit due to the leverage effect.
For instance, if the market goes back to 14,000 from the current 8,000, each Dow Futures contract would increase in value by ₹60,000 (a rise of 6,000 points multiplied by the 10 leverage factor equals ₹60,000). However, it's important to note that the opposite can occur as well. If the market falls, the trader dealing with Dow Futures could face significant losses.
