Understanding Dow Jones futures

Dow Jones Futures | Trade Global Indices With R1Investing

In order to understand Dow Jones futures, we first need to examine what financial futures are in general. 

What are futures?

For an investor, a futures contract, or “futures”, is a legal agreement, a contract, to buy or sell something (usually stock, currency or any asset) in a specified time in the future at a price which is determined at the time of the agreement. Originally futures, such as the Dow Jones futures, were created as a way to protect the parties from the risk of a price change in the future.

For example, if an investor is expecting to receive a payment in USD in a month from the day of the agreement but speculates that the USD price might fall then he might “lock” the exchange at current USD rates, even if the transaction will be in the future. However, futures offer many opportunities for profit, precisely because of the speculation that is involved in the transaction.

Although futures were initially used for commodities, currently currency futures traded in the forex market, interest rate futures and stock market index futures hold a central role in the futures overall market. So how do Dow Jones futures fit into this definition?

Futures in history and in modern times 

Future exchanges have been around a long time. The first in modern times was a rice exchange in Japan, which began in 1710. More recently, the London Metal Exchange began in 1877. In the US, the Chicago Mercantile Exchange, sometimes called “the Merc” was founded in 1898. One hundred and ten years later, the Merc acquired the parent company of the New York Mercantile Exchange and Commodity Exchange, NYMEX Holdings, Inc. 

Dow Jones futures explained 

Having understood what futures are in general, we can say that Dow Jones futures are future contracts which allow investors to speculate on the future value of various components of the Dow Jones Industrial Average market index. 

The Dow Jones Industrial Average (DJIA), is a stock market index that shows how 30 large, publicly owned companies based in the United States have traded during a standard trading session in the stock market. 

In practice, this means that with Dow Jones futures, if the Dow Jones Industrial Average index is above the agreed price by the "final settlement date" then one party will pay the other the difference between the actual closing price of the index and the predetermined price upon which they agreed when the contract was signed. 

Unlike the others

Some traders criticize DJIA investments because it is a price-weighted index. When most companies in other indices (FTSE, NASDAQ, etc.) are weighted according to their market capitalization, the companies in the DJIA are weighted according to the prices of their stocks. Since most indices are market cap-weighted, the Dow Jones index is different and may confuse traders.

However, as a price-weighted index, the DJIA is intelligible in its own way. The value of the Dow Jones index equals to the average stock price of the companies included in it. It allows tracking the average stock price performance of a specific market. For those, who are comfortable with such calculations, Dow Jones futures trading is as comprehensible as investing in other indexes.

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Written by:
Omer Aragón Godínez

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