Some of the most commonly traded forex currency pairs usually include the USD either as a quote or a base currency. In order to make better trading decisions, trading USD based pairs can be convenient when using the US Dollar Index. Bear in mind that you aren’t actually trading the US Dollar Index, also known as USDX, but rather making use of the USDX chart in order to gain perspective on how the pricing comes out when trading USD based pairs. The Dollar index was established by the US Federal Reserve in 1973 after the Bretton Woods agreement was concluded in 1944.
In this article, we take a look at what the USDX or US Dollar Index is and how you can use this information to trade USD based currency pairs.
What is the US Dollar Index
The USDX works similar to the weighted indexes using the exchange rates of major currencies such as the EUR, CAD, CHF, GBP, JPY, SEK. The US Dollar Index gives an overall view of how the USD is performing against the above currencies. In terms of weightage, not all the currencies are given equal weights. The table below describes how the weights are distributed across the different currencies the US Dollar is compared against.
|Japanese Yen (JPY)||0.136|
|British Pound (GBP)||0.119|
|Canadian Dollar (CAD)||0.091|
|Swedish Krona (SEK)||0.042|
|Swiss Franc (CHF)||0.036|
The USDX is calculated 24 hours a day and is measured in the USD’s value to a base of 100.000. For example if you read that the USD moved to 75.364, it means that the USD weakened by 24.636% since the start of the index. The EUR makes up for more than 50% of the USDX and therefore, the currency pair EURUSD usually moves inversely to the USDX. Refer to the chart below to see the inverse chart movement between EURUSD and the USDX.
The US Dollar Index is often refered to in analysis, especially when you hear words such as “the USD is growing strong“, which means that the US Dollar index is increasing. Understanding the US Dollar Index can be a great way to build up your analytical skills when it comes to trading USD based pairs.
Reading the USDX – US Dollar Index
The USDX is specially useful for trading bonds, currencies and gold. For example, a rising USDX would infer a drop in Gold prices and vice versa. Likewise, during times of crisis, the USD (along with few other pairs) are known to be safe haven assets. In such situations, the USDX is often pushed higher which in turn results in a decrease in the bond yields due to higher demand.
From a forex trading perspective, USDX is particularly useful if either your base or quote currency happens to the USD. So if you are trading EURUSD, GBPUSD, USDCHF, USDJPY or USDCAD then using the Dollar Index can be quite a useful resource.
There are primarily three factors that determine the direction of the Dollar Index, these are:
- Supply and Demand for the USD: Deals with how much of dollars are being sold and bought (ex: exports/imports)
- Market sentiment and psychology: Includes strength of the economy and other such factors
- Technical factors: Derived from reading Non Farm Payroll Data, GDP Growth and so on.
Using Dollar Index Charts for Analysis
While in most cases the Dollar Index, especially in the Spot Fx markets are not available to trade, there are some brokers that offer the Dollar Index futures with different contract expiry times. However, for most traders the Dollar Index is used for analysis to find the underlying strength in the Index. The picture below shows the Daily Chart for the US Dollar Index.