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All you need to know about the U.S. dollar Index

01 one US Dollar

The U.S. dollar index or USDX (also known as DXY) for short is an instrument that is widely used across all asset classes. As a forex trader, you should have an understanding of what the USDX is all about. It can be beneficial for your trading as it gives additional information about the markets.

The U.S. dollar index is an index which measures the value of the U.S. dollar, relative to a basket of currencies. There are six currencies that make up the basket. These include in order of weightage:

1. Euro (EUR) – 57.6%
2. Yen (JPY) – 13.6%
3. Pound sterling (GBP) – 11.9%
4. Canadian dollar (CAD) – 9.1%
5. Swedish krone (SEK) – 4.2%
6. Swiss franc (CHF) – 3.6%

The dollar index started in the year 1973 with a base rate of 100. Since then, the value of the dollar index has ben fluctuating. This depends on how the other currencies perform in relation to the U.S. dollar.

The index came into existence after the end of the Bretton Woods agreement. Up until this point, many currencies were pegged to the gold price. However, after the introduction of the dollar index, currencies were now pegged to the U.S. dollar instead of gold.

Since its inception, the dollar index has seen some wild swing. Historically, the dollar index rose to highs of 124 in 1985 while hitting an all time low at 72 in 2008.

The dollar index is currently maintained by ICE (Intercontinental Exchange).

02 DXY

The U.S. dollar Index chart

You can either trade the dollar index futures or simply use it as a tool to analyze the currency markets, which we cover in the next section of this article.


How to trade the dollar index?

The dollar index is primarily available as a futures instrument. This means that investors can buy contracts in the U.S. dollar. The dollar futures are available for trading at the ICE exchange with the code DX.

The contract size is $1000 x the index value. It has a quarterly expiration of March, June, September and December. The dollar index futures allow investors to take a direct position in the U.S. dollar currency.

There are of course some significant advantages for this. For one, investors can use the dollar index futures to speculate. The index is quite volatile. The fundamentals primarily depend on the economic data from the United States.

This means that reports such as the US GDP, unemployment, inflation and central bank meetings can increase the volatility in the dollar index.

Because there are six currencies that make up the basket, one can also use the dollar index as a way to understand their technical analysis better.

The euro currency which has the highest weightage can be better traded and understood and if you understand what is happening the dollar index chart. To a certain extent, the currencies are inversely correlated.

This means that when the dollar index is rising, the EURUSD falls and vice versa.

Therefore, traders can adopt a trading methodology where one can determine the direction of the dollar index chart and then trade the EURUSD. The index is also used for valuing other currencies against the U.S. dollar.

For examples, the AUDUSD, NZDUSD are other currencies that you can use in conjunction with analyzing the dollar index.


Understanding the dollar index chart

Many traders often mistake the view that a rising dollar is good. But this is not the case. Investors are always in search of yield. Therefore, when appetite for risk rises, you can see the risky currencies such as the AUD or the NZD rising sharply, while the dollar underperforms.

Similarly, during times of economic turmoil, investors tend to pile into the safe haven status of the U.S. dollar. Yes, that’s right. The U.S. dollar currency is also seen as a safe haven currency especially when there are concerns abroad.

It is also widely used as funding currency. In other words, investors can borrow in U.S. dollar and then convert that to another currency which gives a higher yield.

You can run the same concepts of technical analysis on the U.S. dollar index. What this can tell you is that when the sentiment is bearish on the dollar index, you can expect the euro currency to outperform.

Thus, instead of looking at the EURUSD in isolation, investors can also use the dollar index chart to give some valuable information.

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