Equities lead futures? Or futures lead equities?

Discussion in 'Index Futures' started by makeorbreak, Oct 16, 2006.

  1. Do the cash indexes drive the futs, or do the futs drive the cash indexes?

    I say the question is no question at all. Cash indexes drive the futures markets, plain and simple. The broad market leads, the ES follows, end-of-story. Someone, please show me the error in my logic. Here's my reasoning:

    Now, I know many have observed that futures lead the $ticks; that's not in dispute. What IS in dispute is whether or not that is a causal relationship.

    If I went out and bought an iPod about three years ago, did I influence the other millions of people to go out and buy one as well? Or is it more likely that the iPod is a very valuable, utilitarian consumer product, destined to become popular on it's own merits, and I was merely one of the first to recognize that and hop aboard the train early.

    This is my main point of contention with those who say that futures lead stocks. I maintain that, due to the sheer amount of volume, the stocks MUST lead the futures. There is no other way it can be. Those who view it as a push-and-pull type relationship -- where sometimes one leads, and at other times the other one does -- are, in my view, wrong.

    Now, this is not to say that futures don't have room to play around the cash value price; they absolutely do. But whenever they get too far out of line (with the fair value), the buying / selling programs hit the market and bring them back to fair value in short order.

    If the volume buying and selling of stocks causes the stock prices to rise and fall, it becomes pretty easy to see how the cash index can lead the futures. If the stocks that cumulatively make up the cash index drive the index ( i.e. the broad market) higher, the futures have no choice but to follow (buy and sell programs will see to that).

    But, someone, please, pray tell, how can the opposite happen? Let me put the question this way, and it's basically a two-parter:

    1.) If the futures DO lead the stocks, how can stocks possibly lead the futures? (Circular "chicken-or-the-egg-argument" logic)

    2.) How can the relatively small number of traders buying in the ES influence the hundreds (if not thousands) of market making specialities in S&P large-cap stocks to automatically buy as well, in order to bring the cash index in line with the futures?

    In my experience, the opposite is the fact: Any excessive exuberance in the futures will soon be quashed and the futures will come back to a more reasonable level. The futures MUST hover around the cash index, not the other way around. It's practically the definition of a cash index.

  2. cash drives futures
    my ex-firm put out bid/ask on the cash market. then use blazing fast programms to hedge cash position with fut pos
  3. Who Cares? And from a practical standpoint, $SPX is only updated every 15 seconds on Esignal, versus real-time with the ES. Thus, even if cash leads, I don't see how watching $SPX over ES results in any edge.
  4. Depends on the method.

    Sometimes you can get a valid pattern signal in $SPX while ES has no valid signal.

    Yet, you can take the trade in ES due to its relationship to $SPX.

    Reason why it pays to watch both.

    In fact, throw in the SPY exchange traded fund...

    Watching all three increases the odds of not missing trade signals regardless if you only take trades in ES or SPY.

    (a.k.a. NihabaAshi) Japanese Candlestick term
  5. Cash drives futures in the end...but I don't think there is much value (relatively speaking) in the SPX. Better to keep an eye on key stocks and sectors. These are what drive the SPX.

    Futures give the illusion that they lead. They'll predict 10 out of every 2 upmoves! The other 8 you might have figured out were not going anywhere by knowing something about the actual underlying stocks. Those were the moves that were quickly reversed.

    I think of futures as something like the balls on a pool table. They are free to move within the railings....but that's it. Futures do the same type of thing...bounded by the underlying cash market.

  6. tortoise???!!!

    So we are on opposite sides of the fence. What is different about the stocks is the sheer number of players on the stock side of the fence. To watch the lead, consider the overnight market. There is no active stocks in overnight trading. There is news but you do not have an index value and despite not having stocks to say, arb against, the futures still move. Take the North Korea nuclear test from 10/7. The market moved 4 points overnight without any basis in the underlying stock index. The most evident places where you can watch the futures lead is on the open and FOMC (fed announcement) days.

    When there is a sizeable gap between the previous days close and current days open, you will find that the offset is arbed out. The duration of the synch nowadays is within 7 minutes. Take the DOW index and it's futures and note that within the first seven minutes you will see that the majority of the time, there will be a spike in the DOW index without a corresponding spike in the futures. I find the reasons to be the exact opposite of yours. What it boils down to is the herd in the index versus the herd in the futures. The futures is but one instrument for which the participants determine it's movement. The index is a collection of instruments with a distribution of participants with varying instruments. Someone trading MSFT may have no trading consideration for the larger indexes movement, and yet the trader will take a position.

    My point is that unlike futures in which the single price is the result of a collection of traders participating in a single instrument, the index is a collection of aggregated prices from a collection of instruments with a much broader variety of speculators, participants, and interests. As a result, it is much easier for the futures to tick up a point then the underlying index to tick up a point since it requires a greater collection of prices to move. The simple observation for you to make would be to plot the DOW futures and DOW index (one on top of the other) using a range bar chart with a 1 point range. For each bar, you will be able to SEE where the bias is with respect to which one leads. You may find your result$ quite intere$ting...

  7. MAK,
    Great post!
    Totally true.
  8. My understanding is that when an institution wants to purchase a large position in equities they will buy the futures first to hedge the expected slippage so it seems possible to me that the futures could lead the cash at least temporarily.
  9. ^^^^^^


    Index data as broadcast is calculated on last trades. There is no minimum tick value for the index as there are for the futures contracts. Therefore, in a mathmatical point of view, if for example the ES trades higher by a tick it will be at a minimum .25 greater than the last trade in the ES. The cash index may actually only move higher by some other amount, for example .15 greater than the last computed cash value. If you plot broadcast index data against futures data the futures will always lead simply because of the lag inherent in broadcast index data.

    As others have stated, the futures are nearly always "away" from the cash value, both over and under valued. However, IMHO the futures traders who really set the pace in the market watch the underlying cash action of the bids/ asks and trades on the highest cap weighted components of an index to get a read on which way to lean on the futures and not vice versa.

    This is easy to see for yourself by setting up a quote page of perhaps the 30 highest cap weighted stocks on the S&P500 index. Its best if your quote page can display a color for an uptick value and a different color for a downtick value on the stocks. Watch both the bids/asks on the stock page and the bids/asks on an ES quote. A heavily offered ES will suddenly "give way" to an uptick when the stocks quotes light up with increasing upticks in the cash.
  10. bighog

    bighog Guest

    Watch what you trade.......................:p

    If i trade ES (and i do) i care less what cash is doing.

    Why complicate things? To many items to watch gives you reasons NOT to take the signal produced from KISS. ...:D
    #10     Oct 17, 2006