The US dollar index – what is it and how to use it on Forex?
What is the US Dollar Index? What currencies are in the basket? How to use it in Forex trading? Where can I view the chart of the US dollar index?
The US dollar index is widely used to measure sentiment against the US dollar. In this article, you will learn what the US dollar index is, what currencies are in the basket, how you can use it in your Forex trading, and where to view the US dollar index chart.
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What is the US Dollar Index?
The US dollar index is an indicator of the value of the US dollar against a basket of foreign currencies. The basket of currencies consists of the euro, Swiss franc, Japanese yen, Canadian dollar, British pound and Swedish krona. The US dollar index is indicated on the chart by the symbol USDX or DXY.
How is the US dollar index calculated?
USDX is the weighted average geometric value of the dollar value compared to the following currencies (the weight of the currency in the basket in relation to the dollar index is indicated in parentheses):
- euro (57.6%);
- Japanese yen (13.6%);
- pound sterling (11.9%);
- Canadian dollar (9.1%);
- Swedish krona (4.2%);
- Swiss franc (3.6%).
Why was the US dollar index created?
It was created shortly after the collapse of the Bretton Woods Agreement (the abolition of the gold standard), and its purpose was to track the dynamics of the dollar compared to the currencies of the main trading partners of the United States. Since the 1980s, it has been sold as a futures contract, and speculators have used it as a way to speculate on the movement of the US dollar against a basket of other major currencies.
The US dollar index was originally created by the US central bank in 1973 to determine the weighted average value of the US dollar for bilateral trade. This was caused by the overiem of the gold standard and floating exchange rates.
The Bretton Woods Agreement created a new monetary system in 1944, after which the US dollar became the most important world currency. According to the agreement, the countries will maintain a fixed exchange rate between their currency and the US dollar.
The collapse of the system began in 1971, when the United States was suffering from stagflation. President Nixon decided to untie the value of the dollar from gold, thereby terminating the Bretton Woods Agreement.
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Why is the US dollar index so important for traders?
Investors follow the US dollar index because it allows them to track the value of the dollar compared to a basket of major currencies. If a trader is convinced that the US dollar will become more expensive everywhere, it may be easier to place one trade, betting on the growth of the US dollar index, instead of managing several positions in the foreign exchange market. Some market participants also use the US dollar index for hedging purposes.
What affects the price of the US dollar index?
The dollar index depends on the supply and demand for the US dollar and the currencies included in the basket. Here are some factors that can shift the index:
- Interest rates. An increase in interest rates in the United States will make the US dollar more attractive to investors, which will lead to an increase in the value of the index. On the other hand, if the market starts to lower interest rates, DXY will be under pressure.
- Capital inflow to the safe zone. The US dollar is traditionally considered a safe haven. During market turbulence or crisis, the dollar is likely to become more expensive. The demand for the currency may decrease during periods when traders are prone to high risk.
- Fundamental news. DXY reacts to the news release, as well as standard ones currency pairs. For example, an unexpected change in the rate of the European Central Bank (ECB) can have a significant impact on the US dollar index due to the large weight of the euro in the basket.
How often is the US dollar index adjusted?
Adjustments are made very rarely. The last major adjustment was made when the euro was introduced. This is one of the reasons why the index has been criticized in the past. The list of the main US trading partners has changed significantly over the past four decades, and it is really strange to see that the Swiss franc and the Swedish krona are represented, and not the South Korean won, the Brazilian real or the Chinese yuan-countries with which the United States already cooperates have established significant trade relations.
European currencies dominate the index, while Asian currencies are underrepresented. This is the reason why various dollar indices consisting of a basket of other currencies may become popular in the future.
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Analysis of the US dollar index
If you use technical analysis in your trading, you can analyze the US dollar index almost in the same way as any other stock index or currency pair.
Applying fundamental analysis may be a little more difficult, since you will have to take into account data and information from different countries. Interest rates play a big role, especially when rumors are growing that the Federal Reserve may change the course of its monetary policy.
However, if a trader plans to use the US dollar index to bet on the direction of the dollar, he should always keep in mind the basket of currencies and their weights. If the US dollar is expected to decline against commodity currencies, such as the Australian or Canadian dollar, for example, due to negative news or slowerThe US dollar index will practically not change, since the weight of the Canadian dollar is low, and the weight of the euro is high, but there is no significant economic growth in these markets, but not much in relation to the euro.
How to trade the US dollar index?
You can trade the US dollar index in the same way as the stock index. Instead of buying and selling several securities at the same time, you will only deal with one. In this case, instead of trading several currency pairs, you can trade a single US dollar index, which should rise and fall in accordance with the general mood of the currency market.
If the USDX is growing, it means that the US dollar is strengthening compared to other currencies in the basket. It is reasonable to assume that if the index is bullish, then the overall confidence in the US dollar will be high.
You can also adjust your long and short positions depending on whether the USDX is rising or falling. For example, if the index is bullish, you can re-evaluate any short positions you have in USDJPY and USDCHF.
Where can I view the chart of the US dollar index?
The USDX chart can be viewed in almost any MT4 trading terminal, if the broker provides the US dollar index as a trading instrument. In addition, it is convenient to track the dynamics of changes in the value of the US dollar index in Investing.com.
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Thus, the US dollar index tracks the value of the dollar against six foreign currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc. The value of the US dollar index is influenced by strong economic news in the United States and the EU. Traders can use the USDX chart to determine the strength of the US dollar when tradinganalysis of Forex transactions.
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