Does future price affect stock price?
Yes they can affect the price of the security to some extent, as the investors and their algorithms look at all this data points to determine the pattern while buying or selling the stock.
How Do Futures Prices Affect Spot Prices? It's actually more the other way round: Spot prices influence futures prices. A futures contract price is commonly determined using the spot price of a commodity—as the starting point, at least.
What are futures? A futures contract is a derivative whose value is based on (or derived from) its underlying asset. It is a financial contract between a buyer and a seller to buy/sell a specific amount of the underlying asset at the agreed upon price on the agreed upon future date.
If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. Understanding supply and demand is easy.
The main difference between spot prices and futures prices is that spot prices are for immediate buying and selling, while futures contracts delay payment and delivery to predetermined future dates. The spot price is usually below the futures price. The situation is known as contango.
This situation is called backwardation. For example, when futures contracts have lower prices than the spot price, traders will sell short the asset at its spot price and buy the futures contracts for a profit. This drives the expected spot price lower over time until it eventually converges with the futures price.
Contango is a situation where the futures price of a commodity is higher than the spot price. Contango usually occurs when an asset's price is expected to rise over time. That results in an upward-sloping forward curve.
A backwardation is a scenario where the futures price of the asset is trading below its spot price. This is observed when the market expects the asset to decrease in value over time. For example, let the spot price for a stock be ₹2,000, and its futures price be ₹1,900.
The Expectancy Model of futures pricing states that the futures price of an asset is basically what the spot price of the asset is expected to be in the future. This means, if the overall market sentiment leans towards a higher price for an asset in the future, the futures price of the asset will be positive.
The assessment of index futures can be an important leading indicator of market sentiment. A high volume of long positions being taken on an index could mean that many traders are bullish on the market and believe the market the index is based on will increase in value.
Why are futures a good indicator?
Futures look into the future to "lock in" a future price or try to predict where something will be in the future; hence the name. Since there are futures on the indexes (S&P 500, Dow 30, NASDAQ 100, Russell 2000) that trade virtually 24 hours a day, we can watch the index futures to get a feel for market direction.
That said, generally speaking, futures trading is often considered riskier than stock trading because of the high leverage and volatility involved that can expose traders to significant price moves.
Some of the common indicators that predict stock prices include Moving Averages, Relative Strength Index (RSI), Bollinger Bands, and MACD (Moving Average Convergence Divergence). These indicators help traders and investors gauge trends, momentum, and potential reversal points in stock prices.
High demand for a stock drives the stock price higher, but what causes that high demand in the first place? It's all about how investors feel: Market sentiment toward the stock. Market sentiment toward the industry.
Stock prices drop for four reasons – economic factors, supply & demand factors, global market forces, and international demand.
Although futures and stocks do have some things in common, they are based on quite different premises. Futures are contracts with expiration dates, while stocks represent ownership in a company.
This method of predicting future price of a stock is based on a basic formula. The formula is shown above (P/E x EPS = Price). According to this formula, if we can accurately predict a stock's future P/E and EPS, we will know its accurate future price.
Backwardation for Investors
You could buy a futures contract at the lower price and hold it. Then as you approach the contract expiration date, you could sell the contract for a profit at the still high spot price.
So what is the possible reason behind the prices that are different at different price frames? Well, it is time to expire, dividends and especially interest rates. The future price is a mathematical representation of how future price change if any of the variables in the market changes.
For example, if an economic recession is expected to develop at some point in the future, the market may move into backwardation to account for slowing demand, which often has a negative impact on prices. Supply disruptions, weather events, and geopolitical events can also contribute to backwardized markets.
Why is futures better than spot?
High leverage: Futures trading often involves higher leverage than spot trading, which can amplify profits. Predictable costs: Futures trading fees are generally fixed, providing traders with more predictable costs.
If futures prices are positively correlated with interest rates, then futures prices will exceed forward prices. If futures prices are negatively correlated with interest rates, then futures prices will be lower than forward prices.
Contango refers to a situation where the futures price of an underlying commodity is higher than its current spot price. Contango is considered a bullish sign because the market expects that the price of the underlying commodity will rise in the future and as such, participants are willing to pay a premium for it now.
Simple to use: Spot trading is relatively straightforward, especially for those new to trading. Less risky: It's less risky than margin and futures trading, which means your losses are limited to the capital you put in.
Perpetual futures are particularly popular among traders in the cryptocurrency market. The funding rate mechanism helps keep perpetual futures prices close to the spot price of the underlying asset.
