If you aren’t a stock market expert, you may be curious why the words “pre-“ and “futures” appear in the same term. They seem to be pulling the clock in different directions. In fact, pre-market futures are an important indication of trading sentiment for stock investors worldwide. They can act as tools traders use to predict the short-term direction of the major stock indices.
Trading the Stock Market
Stocks are bought and sold on stock exchanges (these are “listed” stocks) or through over-the-counter transactions arranged by stock brokers (for listed and unlisted stocks). Specialists and market makers on the stock exchanges execute buy and sell orders from customers. Prices respond to the demand and supply of stock shares. Stock investors can also buy exchange-traded funds, which are baskets of stocks that trade as a single unit tied to an index.
There are several major world stock indices.
- Dow Jones Industrials: This is an index of 30 large US stocks traded on the New York Stock Exchange (NYSE).
- Nasdaq 100: This index includes the largest 100 stocks listed on the Nasdaq exchange.
- S&P 500: This is an index from Standard & Poor’s 500 top US publicly traded companies.
- DAX: This is an index of 40 prominent German stocks.
- FTSE 100: This is a London-based index of 100 large stocks.
- Nikkei 225: This index includes large stocks on the Tokyo Stock Exchange.
An S&P 500 ETF allows you, in a single order, to buy a proportionate share of all 500 stocks in the S&P 500 index at a price determined by the constituent stocks.
The stock exchanges have core trading hours in the US from 9:30 a.m. when the market opens to 4:00 p.m. ET, market close. In addition, exchanges such as the NYSE on Wall Street offer an opening session for stock trading (often called the “pre-market”) from 4:00 a.m. to 9:30 a.m. ET. The NYSE also has an after hours trading session (the “aftermarket”) from 4:00 p.m. to 8:00 p.m.
A stock index refers to a basket of individual stocks or an exchange-traded fund (ETF, a bundle of stocks that trade as a unit, similar to a mutual fund). A stock index’s price derives from each stock in the index.
Many stock traders closely follow the short-term price movements of the major indices and individual stocks. The futures market predicts how stock prices will fare when the stock markets open for core trading.
Trading the Futures Market
Futures are financial contracts that derive their value from underlying commodities (e.g., crude oil, currencies, cryptocurrencies, etc.) and financial instruments (e.g., stocks, ETFs, bonds, etc.). Traders buy and sell stock and index futures contracts (such as E-mini S&P 500 futures and Nasdaq futures ) to profit from price changes of the underlying assets and/or to arrange to make or take delivery of those assets on a date certain.
A futures stock contract allows you to control a set number of shares (or the value of a stock index) for a set period. Stock futures offer certain advantages over stock shares, which is why they are widely traded on global exchanges. One advantage is that you can trade them around the clock, including the pre-market hours for stocks.
Understanding Pre-Market Futures
Trading pre-market futures involves purchasing and selling futures contracts before the stock exchanges open their core auction sessions. In other words, “pre-market” refers to stock exchanges, not futures exchanges. You can trade futures with an online broker any time you want (including the stock exchange pre-market hours) because there are always futures exchanges open somewhere in the world.
Pre-market trading is crucial because you can compare the value of index or stock futures against the previous day’s stock closing prices. “Fair value” is an indication of the relationship (or “spread”) between stock and futures prices. Traders look for bullish or bearish signals from the volatility in fair value, especially during stock pre-market hours.
If you tune into CNBC or other investment channels during the pre-market hours, you’ll notice frequent mention of how the futures fair values are changing and what they predict for stock prices when the stock markets open for core trading. Astute traders may use this information to time the purchase and sale of stocks and ETFs. Some believe stock futures predict bull market rallies and bear market declines.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.