Dollar Index Trading
What is the US dollar index
Dollar Index chart, or Dixie as it is often referred to, is the most popular currency index in the world. It trades under the USDX or DXY tickers on most exchanges. The index measures the value of the US dollar relative to a basket of foreign currencies.
The US dollar index was started in March 1973, when the world’s largest nations met and agreed to freely float their currencies against each other. This was soon after the Bretton Woods agreement was abandoned. For its part, the US dollar index was purposely created to provide an external consensual trade-weighted average of the dollar’s value.
The index was initiated at a value of 100.00, which was referred to as the base value. As such, when the index value is 80, it signifies that the dollar has lost 20% of its value; and if it is 120, it signifies that the dollar value has appreciated by 20%. Historically, the dollar index chart touched a high of 148.1244 in February 1985, and a low of 70.698 on March 16, 2008.
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Who trades the US dollar index
The US dollar is still considered the world’s leading reserve currency. This makes the USDX a vital component in predicting moves on the financial markets. Most commodity prices, such as gold price, are quoted in dollars, so that when the value of the USDX increases, commodity prices usually decrease, and vice versa. Bond traders also watch the USDX, as yield rates generally decline when the dollar’s value appreciates, especially during periods of recession.
But it is in the currency markets where the USDX is actively watched. Virtually all the major pairs have the USD as a component, and these include the EUR USD, USD-JPY, GBP USD, USD CAD, AUD USD and the NZD USD.
Determining the direction of the USD is essential in determining the direction of the entire market. For instance, a EURUSD trader will buy the pair if the USDX is falling (implying decreasing dollar value) and sell it when the index is rising. Commodity trading, trading forex and stock market traders all watch the US Dollar Index when making their predictions.
The USD index calculation
The value of the USDX is determined on the basis of a basket of major global currencies. Its computation has been changed only once – in 1999 when the euro (EUR) replaced multiple European currencies.
The current currencies included in the USDX mix, as well as their relative weights, are as follows:
| Currency | Weight (%) |
|---|---|
| Euro (EUR) | 58.6 |
| Japanese Yen (JPY) | 12.6 |
| Pound Sterling (GBP) | 11.9 |
| Canadian Dollar (CAD) | 9.1 |
| Swedish Krona (SEK) | 4.2 |
| Swiss Franc (CHF) | 3.6 |
Using the above-assigned relative weights, the USDX is then calculated using the formula below:
USDX = 50.14348112 × EUR/USD^ (-0.586) × USD/JPY^ (0.126) × GBP/USD^ (-0.119) × USD/CAD^ (0.091) × USD/SEK^ (0.042) × USD/CHF^ (0.036)
How to trade the US dollar index
The USDX is available in the options and futures markets, where multiple timeframe contracts are offered. The index is also available as an ETF on the ICE exchange. Due to the significance of the US dollar in financial markets, investors utilise the dollar index as a natural hedge for positions placed on the currency markets.
As indicated earlier, the US dollar is the highest held reserve currency in the world. The dominance of the US dollar in international trade is thus clear, and this makes the price of the USDX relatively stable and not prone to significant external shocks. Changes in the exchange rate, however, can change the prices of exported and imported goods between countries.
For example, as the USD strengthens against the Japanese yen (JPY), more JPY is required in order to buy the same dollar value of US goods exported to Japan, making this more expensive for foreigners. Movement in the DXY trading chart largely impacts the international trade balance, providing many trading opportunities for investors worldwide.
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