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Is The US Pre Market Futures A Good Indicator?

Wednesday, February 20, 2008

Here's an article worth reading. Posted on Spore Business-Times

  • Hang Seng outdrives Dow futures

    By R SIVANITHY

    REGULAR BT readers and close observers of stock-market movements would know of the reliance traders place on rises and falls in the futures market for US benchmarks, most notably the Dow Jones Industrial Average or the Dow futures for short.

    The idea here is that the Dow futures in theory captures the market's best guess of how Wall Street might perform when it opens about five hours after Singapore closes, so if the contract rises sharply, then chances are US stocks will be strong. Conversely, if the futures market is very weak, then caution might be the order of the day because it suggests a Wall Street fall.

    However, because volume traded in the Dow futures during Asian trading hours is generally low - only a few hundred contracts are typically done between 9am-5pm local time - observers have pondered the possibility that speculative funds might regularly manipulate the Dow futures in order to influence sentiment in local stocks.

    Adding to this notion is anecdotal evidence that the Dow futures tends to be a poor predictor of how Wall Street performs over the course of its own trading day - a jump in Asian trading does not necessarily translate every day into strong Wall Street closing.

    While possible, the idea that the Dow futures is rigged to sway sentiment in Asia is highly improbable. For one thing, even though volume appears low, it still requires a fair amount of financial muscle to rig the Dow futures.

    The contract is traded on the Chicago Board of Trade's electronic trading platform and is valued at US$10 per index point. An index value of 12,500 means that one contract is worth US$125,000. In yesterday's trades, some 650 contracts were done during the time the local stock market was open, which means the total value of trades done was around US$81.25 million - not a small amount by any means.

    Second, futures traders have no way of knowing whether the US economic reports to be released later in the day will be good or bad, or if US companies are about to announce strong or weak earnings. The Dow futures is illiquid in Asian trading because traders have no primary underlying market to refer to in terms of newsflows, and this is why the contract might appear to be a poor predictor of future Wall Street performance.

    Third and most important, the Dow futures plays only a supporting role to the main driver of Singapore stock prices - Hong Kong's Hang Seng Index. Close market watchers would know that it is gyrations in the Hang Seng that are much more influential in affecting sentiment and setting direction for local stocks than movements in the Dow futures.

    There are many reasons for the heavy dependence on Hong Kong but all rest on the fact that the former British colony is by far the largest and most liquid market in this part of the world. An institutional dealer summarised the reliance on Hong Kong nicely when she said 'people tend to follow liquidity and you don't get more liquid than Hong Kong'.

    Furthermore, Hong Kong is viewed as being a good proxy for future Wall Street movements, perhaps even better than the Dow futures itself.

    Daily survival in an environment as volatile as the current one is all about trying to anticipate how the US might move later in the day, so institutions which expect Wall Street to move in a certain direction are much more likely to try and capitalise on this expectation via the liquid Hong Kong market than the relatively illiquid Dow futures.

    Of course, in a globalised world where everything is connected to everything else, it isn't just Hong Kong that directs what happens in the Singapore market. Equally relevant in the early part of the day are movements in Australia and Japan, but especially the latter given its size and liquidity. Then there's China - traders will recall, for example, the turbulence here when China stocks suffered a mini-crash last year. And after Hong Kong closes at 4pm local time, movements in Europe become relevant during the final hour.

    All trading, however, boils down to trying to guess how the US might perform in the future and oddly enough, it's worth noting that it is Hong Kong which plays the most important role in this respect - even more so than the Dow futures.

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