In the equity indices, does every price movement have to be a direct reflection of the basket of stocks they represent or can market makers still move the market as they please in the short term as they would in forex and others?

The market is free to move any way the participants push it. Of course, if there's much deviation it will be quickly arb'd out. Also, understand that the index is very top heavy. So, just ballparking here, but -- the bottom 40 stocks only contribute about ~1% to the index. So, if those stocks all moved down 1%, collectively, in unison, the SPX would only move down half a point (2 ticks in the ES).

So, it doesn't *have* to do anything, but as sure as a $20 bill on the ground won't last long, when an arbitrage opportunity presents itself, things will even out quickly (IMO, within milliseconds to maybe a second or two at most--just my guess, no data to back this up).

Said another way: ES can move stocks, and stocks can move the ES. And don't forget one of the biggest components out there: options (SPX index options in particular). There is a constant push/pull happening, and the rubber band only stretches so far before it returns back to normal.

Thanks for this. From what I was reading, the DOW is built differently than the ES. I believe I read that any $1 move in any of the 30 stocks in the DOW will cause it to move precisely by its DOW Divisor. Would you say the same arb principals would apply here? Essentially arb algos are going to kick in either on the stocks or in the DOW index to adjust for imbalances in order for the index to properly "track" the way it's supposed to? This has always perplexed me a bit, how an index "moves according to it's participants actions" yet it has a mathematical formula for staying in step with what the participants in multiple other markets are doing simultaneously.

-source- Investopedia.djia. ( I can't post links)

Yes, the DJIA is a price-weighted index, while the SPX is a cap-weighted index, so they are different in that respect. However, they would be arbitraged the same way, I think.

The key here is that SPX != ES, just like DJIA != YM. The SPX and DJIA are indexes, and there is a formula, and you can calculate it on your own, in real time, if you want to! However, the ES and YM are derivatives, and hence do not have to move in sync with the underlying index they track. Obvious, but important difference.

A scenario: someone hedges an underlying equity position by buying a few hundred or thousand SPX puts, market makers sell ES futures to hedge, and ES goes down 2 points. This is not directly reflected in the underlying stocks yet. But the stocks *will* get sold, in absence of any other input, because the basket of 500 stocks could be sold (in the correct ratios) to yield a short market value which is 2 points higher than the current value, ES futures could be bought 2 points lower, and a 2 point arbitrage on a multi-million dollar position could be attained.

As has been pointed out in a recent FIO webinar, market makers (think Citadel and Virtu) are hedging positions before the original trade ever really hits the market, because they pay for order flow, for one thing. So, you will never observe with your eyes a case where ES is sold and the component stocks don't go down, or vice versa, because these arb opportunities are done before you can blink your eye.

Add to this individual stock options and futures, bond yields, USD value, and other things, and you can see that the world is very interconnected, with each piece affecting another in some way.

Another interesting phenomenon: when SPX is pinned due to hedging activity, and some component stocks go higher, others, for no reason other than being arb'd to the index, must go lower. This happens, is a real thing, and is described in detail in the Cem webinar mentioned above.