How To Use S&P 500 Futures To Get A Heads Up On Stock Price Action
As we know, to be successful traders,
we should not fight the overall trend
of the stock market. If we are experiencing a weak market, we should sell our
stocks or look for short selling-opportunities. On the other hand, in a
strong uptrending market, we will be aggressively looking for buying opportunities.Â
In addition to the overall trend of the stock market, we should not forget to
monitor the S&P 500 futures index. This index consists of 500 leading
companies from various industries, and its underlying index is S&P 500
cash index. In general, if the S&P futures is uptrending,
this is a bullish sign for stocks. But if the S & P futures dives, it will cause a
sell off in the stock market.Â
A successful trader shared an interesting story with me recently. On December 6,
Bank of America, one of the S&P components, announced its fourth quarter
earnings would be less than the consensus estimate. This warning came during the
afternoon trading session and hit the bank stock hard. Sell off was sharp and
quick. The S&P 500 futures was also touched by this news and sold
off.Â
Two trading days later, on December 8 at the market open, we observed
fascinating price movements in both the S&P 500 futures and Bank of America
stock. As you can see on the charts below, both of them gapped up.
Remember, investors abandoned Bank of America because of its earnings shortfall,
but the stock gapped up on the open as well. You might say the stock was way oversold. It had to rebound sooner or later.
But the point I am making here is
“timing.” Why did Bank of America have to gap up at the same time the S&P gapped up? In addition to
the gap-up opening, both the stock and the S&P futures pretty much traded in
similar patterns the rest of the day. Was this just a coincidence? I don’t think so.
It is impossible for Bank of America to improve its fundamental conditions convincingly
in two days, so all traders would decide to buy in the same morning. I have to
say that Bank of America received a big push from the S&P futures in the
morning of December 8.Â
There is one more example from the successful trader I would like to share. Do
you remember Intel, one of the S&P 500Â companies, warned of an earnings
shortfall after the final bell on December 7? As we saw on the chart above, the
S&P 500 futures made a gap-up open on December 8. In spite of a negative
earnings news from
the previous day, Intel also gapped up. (Please see the chart below.) Was it
another coincidence? I heard investors say bad news was already discounted into
Intel’s price. That could be the case, but I have to question the
“timing” of the gap-up. Again, I have to say that Intel received a big
boost from the S&P futures. In other words, Intel followed them.
As I mentioned above, companies like Intel and Bank of America, which belong
to the S&P 500 futures index, would be hit first when the index jumps. In other
words, leaders from each industrial sector will be affected first when the
futures moves. Pay attention to those leaders such as Yahoo! from the internet,
Lucent from the networking, IBM from the computer makers, and Intel from the
chip makers. They will quickly react when the S&P moves. Unfortunately, if
you could not catch those sector leaders, try to catch second leaders in each
sector. For example, if you failed to ride on Intel, try Advanced Micro Devices.
If Yahoo! ran away from you, see what Amazon is doing. In general, those second
leaders in each sector will follow sector leaders.
Daytraders may want to note the following points mentioned by Mr. Jea Yu in his
book TheUndergroundtrader.com
Guide To Electronic Trading:
“We like to put the S&P 500 futures on three-minute stochastics charts. The three-minute stochastics gives us a smooth and very real visual on
the trend of the futures. When the two oscillator lines (%d, %d slow) fall under the 20 band, the
futures are in oversold territory and one anticipates a reversal up. When the two oscillator
lines run above the 80 band, the futures are in overbought territory and one anticipates a
reversal down.”
We are stock traders, not futures traders. We realize futures influences the
stock market, but we cannot afford to stare at the S&P 500 all day long.
How can we monitor the futures effectively? If a stock jumps above its
resistance level, that is a breakout. When we see a stock fall below its
support line, we call it a breakdown. Often those breakouts and breakdowns
create wild price swings. What I am suggesting is you should program support and
resistance levels of the S&P into your computer, so you will be alarmed properly
when those levels are hit. Please check our website every night. We report Futures
Pivots, Support and resistance.
Some of you might say that you don’t think your stocks would be affected by the
S&P futures price fluctuations because you do not own any stocks represented
by the index. You may be right, but let me ask you questions. Do you own bank
stocks or brokerage stocks? Do you have any oil stocks or airline stocks? If you
answered yes to any of the questions, you need to pay attention to the
futures markets.
Bank and brokerage stocks are interest rate sensitive. In general, they prosper
under low interest rates environments. The chart below is the Bank Index. It has been
rallying since late November, and the index recently broke out above its 50-day
moving average.Â
Now let’s see the 10-year US Treasury Note (March 2001 contract) from the
interest rate futures. As you can see clearly, the 10-year note has been
surging since early November. This rally had started almost two weeks before the
bank
index began its upward movement. Although the 10-year T-Note did not signal to us
the exact moment to get in bank stocks, it certainly warned us of a potential
trend change in the bank sector.
Airline industries would be negatively affected by rising fuel cost. The two charts
below illustrate how rising crude oil future prices hammered down the airline
index.
Sometimes we experience sudden sharp ups and downs of the market caused by
program trading. This is also related to the futures index. Many of you probably
heard “fair value.” I would like to recommend you not spend too
much time trying to figure out when program trading would occur. Let me explain
why.Â
There are three numbers of program trading: fair value, buy premium, and sell
premium. ( If you are interested in calculating fair value, please read the
article by Kevin
Haggerty.)Â The premium is the difference in value between the S&P futures
index and the S&P cash index. If this premium equals fair value, we would
not see program trading. When the premium widens to the buy premium, the buy
program would hit the market. If the premium narrows to the sell premium, we
would see the sell program. The buy
program means buying the cash (stocks) and selling the futures. The sell program
is selling the cash (stocks) and buying the futures. The problem is each brokerage
house has its own methods to calculate program trading numbers. The only thing
one can do is to estimate what those numbers might be, so don’t spend too much
time on this subject.Â
Finally, in addition to the S&P futures, I would like to suggest one non-futures indicator. Make a habit of following the advance-decline line. If we
are consistently seeing more stocks are down than up, we should hesitate
aggressive buying because it is almost impossible for the market to sustain a
healthy rally
under negative advance-decline line. Let me state again. We all want to be
successful traders. We have to know the overall trend of the stock market. We
should buy stocks from strongly uptrending sectors. Although it is tough to pinpoint when we
will get a boost from the futures, we should not forget to monitor the direction of the S&P 500 and other futures indices. Good luck and happy
trading.Â
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