Have you ever wondered how analysts and reporters determine if the market is going to open higher or lower than it closed yesterday? You know how it goes. You wake up in the morning, pull up your favorite stock investing Web site and see a headline stating “Markets Heading for Lower Opening Today.” But how do they know? What are these analysts looking at that tells them the market is heading for a lower opening today?
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Stock traders typically look at two sources to determine what they believe is going to happen to stock values when the U.S. trading session gets underway at 9:30 a.m. Eastern: 1) international stock markets, and 2) futures contracts on stock indices.
International Stock Markets
International stock markets—like the Tokyo Stock Exchange and the London Stock Exchange—can give you a good idea of what is going to happen in the U.S. stock market because stock markets around the world are becoming increasingly interconnected. What happens in Asian stock markets affects what happens in European Stocks markets, which in turn affects what happens in U.S. stock markets. Since the U.S. stock market is the last market to open on a given day, U.S. investors have the advantage of being able to look at how other stock markets around the world have been reacting to news that was released after the U.S. stock market closed the previous trading day and determine how the news is going to affect U.S. stocks. Of course, you could say the Asian investors have the same advantage of being able to see how the U.S. stock market reacts to news that is released during the U.S. trading day too because it really is just one big circle of stock markets opening and closing around the world every day.
As investors wake up in the U.S., they look at how other indices around the world—like the Nikkei index in Japan, the DAX index in Germany and the FTSE index in London—have been performing that day, and they are able to get a pretty good idea of how the S&P 500 and the Dow Jones Industrial Average are going to perform at the beginning of the trading day in the U.S.
Futures Contracts on Stock Indices
Both of the major U.S. stock indices—the S&P 500 and the Dow Jones Industrial Average—have futures contracts that trade based on their respective values. When the value of these indices increases, the value of the futures contracts increase. When the value of these indices decreases, the value of the futures contracts decrease.
One important characteristic of futures contracts is that they trade virtually 24 hours per day. This means you can look at the value of either the futures contract for the S&P 500 (SPX) or the futures contract for the Dow Jones Industrial Average (ES) before the stock market opens and see where the futures contract is trading. If the price is lower than the closing price from yesterday, you know the stock market is probably going to open lower. If the price is higher than the closing price from yesterday, you know the stock market is probably going to open higher.
Image courtesy Dan Quiroz.