If Dow Futures are currently trading at 6,000, for example, a single futures contract would then have a market value of $60,000. For every $1 (or “point” as it is known on Wall Street) the DJIA fluctuates, a single Dow Futures contract has an increase or decrease of $10. The position you take on a trade is the purchase price you have agreed upon with the seller. Dow Futures contracts trade on an exchange, meaning that the exchange is who you deal with when you create your position (your price and contract) on the commodity. Because index futures don’t require investors to put up the full 100%, you need only to maintain a small percentage in your brokerage account.
How Do You Trade Index Futures?
This means there will be no delivery of the underlying asset at the end of the contract. If the index price is higher than the agreed-upon contract price at the expiry date, the buyer makes a profit while the seller (known as the future’s writer) suffers a loss. In the reverse scenario, the buyer suffers a loss while the seller makes a profit.
The latter allow traders to buy or sell a specified amount of a commodity at an agreed-upon price on an agreed-upon date in the future. Contracts are usually exchanged for tangible goods such as cotton, soybeans, sugar, crude oil, gold, etc. The Dow is often considered synonymous with “the stock market,” though the S&P 500 Index, which is comprised of at least 500 constituents, more broadly represents the U.S. equities market. Still, Dow index futures are a popular tool for getting broad-based exposure to the U.S. equity market or hedging such positions. J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor. It’s important to note that index futures contracts are legally binding agreements between the buyer and seller.
As the value of the trade climbs before expiration, the broker can require that more funds be added to the account. Futures contracts don’t require the buyer to put up the entire value of the contract when entering a trade. Instead, buyers must keep just a fraction of the contract amount in their account. The Dow Jones futures use a multiplier of 10 (often called 10 to one leverage or 1,000% leverage).
Investors who take long positions speculate that the index’s price will increase, while those who take short positions bet that the price will drop. Various factors can move markets, which means they can go in any Trading gold futures strategy direction, though some directions are more likely than others. Only enter into futures once you’ve gained ample experience in the market, and never invest more than you can afford to lose. Dow Futures have built-in leverage, meaning that traders can use significantly less money to trade futures while receiving exponential returns or losses. This can allow traders to make substantially more money on price fluctuations in the market than they could by simply buying a stock outright.
Contracts
If you own a futures contract, you may hold it for as long as you’d like up to the expiry. Investors can often roll over the contract to the next month to avoid the costs related to settling the futures contract. Traders who invest in equity Theory of reflexivity index futures speculate on the index moving in a particular direction.
The trader must understand that many factors can drive market index prices, including macroeconomic conditions such as economic growth and corporate earnings. Portfolio managers often buy equity index futures as a hedge against potential losses. If the manager has positions in many stocks, index futures can help hedge the risk of declining stock prices by selling equity index futures.
Putting these together, an index future is a legal contract that obligates traders to buy or sell a contract derived from a stock market index by a specific date at a predetermined price. Since many stocks tend to move in the same general direction, the portfolio manager could sell or short an index futures contract if stock prices decline. If there’s a market downturn, the stocks within the portfolio would fall in value, but the sold index futures contracts would gain, offsetting the losses from the stocks. Index futures trading can be riskier than stock trading, especially when leverage is involved, which can amplify both gains and losses. While index futures offer diversification since they’re based on a broad market index, their volatility and the potential for rapid financial changes heighten the risk. In contrast, stock trading allows investors to avoid inherent leverage, limiting losses to the invested amount.
Buying Futures With Leverage
Traders can use these contracts to speculate on the price direction indexes, such as the S&P 500 and the Dow Jones Industrial Average (DJIA). Popular futures include fractional index futures that trade at lower prices than those aimed at institutional investors, like the Chicago Mercantile Exchange’s (CME) E-mini S&P 500. Investors also use index futures to hedge their equity positions against potential losses. The Dow Jones is the stock market index; the Dow Jones Industrial Average (DJIA), which tracks 30 of the most prominent companies that trade on U.S. stock exchanges.
That simplicity, the high trading volumes, and the leverage available have made Dow futures a popular way to trade the overall U.S. stock market. Essentially, they are agreements to trade the value of an index at a future time, reflecting expectations of the index’s future direction in price. Originally intended for institutional investors, index futures are open to individual investors.
- Unless the contract is unwound before expiration through an offsetting trade, the trader is obligated to deliver the cash value on expiry.
- To hold the position, you must maintain sufficient capital in your account to cover the maintenance margin.
- A trader can buy an E-mini Dow contract for about $5,500—and that futures contract is worth $5 for every point on the DJIA.
Futures are a much more complex financial instrument than stocks and bonds and should only be traded by experienced investors. Futures can certainly help an investor realize profits but should be traded with care. Unlike the stock market, financial futures trade six days a week, Sunday through Friday, and nearly around the clock. There are now two Dow futures contract sizes available, both of which trade on the Chicago Board of Trade (CBOT) and Chicago Mercantile Exchange (CME).
Index futures can be bought and sold and their value changes with the value of the index. For example, if you opened the trade by buying five E-mini Dow contracts, you would close the trade by selling them with the same futures contract expiration date. If you opened by selling five contracts short, you would need to buy five to close the trade. When the contract expires, the buyer of the contract pays the agreed-upon price for the underlying asset, and the seller must trading strategies and systems deliver it.
For example, the E-mini S&P 500 futures contract, which trades on the CME, has a value of $50 times the value of the index. So if the index trades at 3,400 points, the market value of the contract would be 3,400 x $50 or $170,000. Outside the U.S., there are futures available for the DAX Stock Index, which comprises 30 major German companies, and the Swiss Market Index; both of these futures trade on the Eurex. In Hong Kong, Hang Seng Index futures allow traders to speculate on that market’s major index. When you open a position, the broker will set aside the required initial margin amount in your account. To hold the position, you must maintain sufficient capital in your account to cover the maintenance margin.