Pre-Market Data

Grasshopper, If you get into the stock market, whether for just trading stocks or something more involved like stock options, you should look at pre-market data. The information I find most helpful are the Futures, Fair Value and the Implied Open of each index. I am referring to the Dow Jones, Nasdaq and the S&P 500.

Every morning before the US stock exchanges begin trading, TV programs and websites providing financial information will give the quotes for the Dow, Nasdaq and the S&P futures. The quoted price movements of the futures contracts in early trading is used by some traders as a gauge for how the overall exchanges will perform at market open and over the trading day. If the index future (Dow, Nasdaq or S&P) is trading higher before the market opens, it generally means that the actual index will trade up in the early part of the day. This is because the index futures are closely tied to the actual indexes. These futures contracts mirror the underlying index and act as a precursor of the actual exchange index’s direction.

Fair Value (FV) and Implied Opening involve a very complicated mathematical formula to figure out. I don’t think it’s as important to understand how the Wall Street gods arrive with the Fair Value and Implied Open figures as it is to simply know what they are.

Without going into a long PhD lecture of how one calculates fair value and its relationship to the futures price, I’m going to provide you with a very basic understanding of the relationship and how you, as an investor can use the information. Most financial websites and media networks calculate fair value for the viewer, so no need to worry about the math. Just understand that the fair value is where the front month future should be trading, according to the mathematical calculation. However, with the futures market open through the night and the equity markets open for a limited session  of 9:30AM to 4PM (EDT) during the day, external factors, such as supply and demand, will often have the futures price deviating from Fair Value. It is this deviation that is often reflected by the media networks (CNBC, Bloomberg, Fox Business) in the pre-market hours in an effort to provide investors with an Implied Open for the index, or in other words: market sentiment. The index’s (Dow, Nasdaq or S&P) Futures figure and Fair Value figure will give the Implied Open figure. If the Implied Open of the Dow Jones is +70 at 9:25AM, an investor will look for the Dow to be up 70 points when the market opens at 9:30.

The following is how you might see the Dow Jones Futures & Fair Value (FV) on your favorite financial network:

Dow Futures: +5

Dow FV: +1

Implied Open: +4

To calculate the Implied Open you must remember to use the Fair Value (FV) as your line in the sand. The Implied Open is the difference between the Fair Value (FV) and the Futures. Follow the examples on the line graph below. If you put your line in the sand on the +1, which would represent Fair Value and you move to the +5 which is the Futures, you would move 4 spaces. The Implied Open for the Dow Jones on this day would be +4. Investors would look for the Dow to open up 4 points at the opening of the market. This would be a bullish market sentiment.

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Let’s look at a few more examples:

Dow Futures: +3

Dow FV: +10

Implied Open: -7

Remember we start with the line in the sand with Fair Value at +10 and travel to Dow Futures to determine Implied Open. As you see, if we did that it would be a Bearish sentiment. We would go back 7 spaces and the Implied Open for the Dow is -7 points.

Dow Futures: +10

Dow FV: -10

Implied Open: +20

Now we have the Dow Futures at a +10 and the Dow Fair Value is at a -10. This is a bullish sentiment. We start at the FV of -10 and go to the Futures of +10 which has us move up 20. This day the Implied Open of the market is up 20 points. Very often we will have much larger numbers. We might have the Dow futures at +45 and the Fair Value at -25. This would be an Implied Open of +70 points.

While this relationship can appear very complicated, and has historically been used as an institutional indicator for program trading, the “Main Street” trader can also use the relationship as a basic indicator for market sentiment. Please note, however, that this information should not be used for stock or option selection, merely an indicator of market conditions.