Do Futures Predict Stock Prices?
Options traders are not clairvoyants.
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Stock futures aren't a prediction as much as a bet. A stock futures contract is a commitment to buy or sell stock at a certain price at some future time, regardless of what it's actually worth at that moment. The prices offered for futures contracts are based on where investors see the market heading. Their vision may be spot-on, but it can also be way off base.
How They Began
Futures contracts began in agriculture. Farming is a risky business, and the contracts gave farmers a way to lock in prices before they went to market. The contract guarantees the farmer a good price even if the market ends up flooded with produce, while the buyer gets a price he believes will turn a profit. The futures concept rapidly expanded into other fields of economy and investment, including oil contracts and, of course, stocks.
Uses
There are two reasons to invest in futures -- to speculate and to hedge. A speculator who thinks the market is going up, for instance, agrees to buy at a price higher than today but lower than he thinks the stocks will be worth. Hedging minimizes losses. If, say, you're holding stocks in the hope they increase in value, a contract to sell for a preset price can reduce the amount you lose if you bet wrong.
Wisdom of Crowds
A singles futures contract doesn't tell you much because it's just one guess. The stock index futures market is much more than a single contract though: it's thousands of contracts, representing the collective view of thousands of traders as to where the market is going when trading opens. If you're looking for insight and you see traders offering lots of futures contracts lower than yesterday's closing price, that's a sign the expert consensus is that the market is slumping.
Limits
Futures investors aren't fortune-tellers. Unexpected events -- war, a terrorist attack, a market panic -- devastate the market precisely because nobody saw them coming. The consensus about where the market is headed can be wrong even without such catastrophes. Even when consensus opinion is accurate about the state of the market at opening tomorrow, things can shift and change wildly during the day. Futures are a useful source of information but shouldn't be your only source.
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Writer Bio
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.