How to use the US Dollar Index in Forex

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At Orbex, we publish a weekly analysis on the US Dollar Index, accounting for both the technical and the fundamental events shaping the markets. What is the US Dollar Index and more importantly how can the US Dollar index be used in the forex markets? In this article, we outline the basics on the US Dollar Index and how traders can use the information in trading the forex markets.

What is the US Dollar Index anyway?

The US Dollar Index or DXY or USDX for short is a trade weighted index of the US Dollar. It measures the value of the US Dollar relative to a basket of currencies. These currencies are made up of the biggest trading partners. In the basket of currencies the US Dollar is measured against, include the Euro*, Yen, Canadian Dollar, British Pound, Swedish Krona and the Swiss Franc, in the order of the highest weightage to the least.

* Prior to the Euro, the US Dollar Index contained ten currencies with the West German Mark, Italian Lira, French Franc, Dutch Guilder and the Belgian Franc.

The table below breaks down the above currencies in terms of their weightage.

Currency Weight
Euro (EUR) 57.60%
Japanese Yen (JPY) 13.60%
British Pound (GBP) 11.90%
Canadian Dollar (CAD) 9.10%
Swedish Krona (SEK) 4.20%
Swiss Franc (CHF) 3.60%

 

The US Dollar Index value is compared to March 1973, when the major trading economies started to free float their currencies against the US Dollar. The index was available for exchange trading since September 1986 and is traded as futures and options. Some brokers also allow for the US Dollar Index to be traded as a CFD.

The US Dollar Index is calculated in real time from the index’s component currencies.

Types of US Dollar Index

There are different versions of the US Dollar Index floating around. The most popular of these all is the ICE US Dollar Index. Other versions include:

  • Wall Street Journal Dollar Index (BUXX): This version of the US Dollar Index tracks 16 currencies based on the data provided by the Bank for International Settlements or BIS
  • Dow Jones FXCM Dollar Index (USDOLLAR): Also known as the USDOLLAR for short tracks the US Dollar against basket of four currencies which are Euro, Yen, British Pound and the Australian Dollar. The USDOLLAR is relatively new and starting being used since January 2011 and started with a value of 10,000

The chart below shows a comparison of the all three versions of the US Dollar Index (BUXX, DXY, and USDOLLAR).

 BUXX, DXY, USDOLLAR (Courtesy: WSJ.com)
BUXX, DXY, USDOLLAR (Courtesy: WSJ.com)

In this article, when referring to the Dollar Index, we mean the DXY or the ICE US Dollar Index.

How can the Dollar Index help in forex?

Because the US Dollar Index is updated in real time and reflects the currency moves against which it is compared to, technical analysis of the DXY can help traders to understand or at times see potential trading opportunities that one might miss. The biggest advantage of analyzing the DXY charts is the fact that because the Euro is weighted by over 50%, you can always make use of the DXY analysis to confirm that of the EURUSD analysis, or vice versa. The chart below shows the strong inverse correlation between the DXY and the EURUSD.

EURUSD v/s DXY (Courtesy: WSJ.com)
EURUSD v/s DXY (Courtesy: WSJ.com)

The next chart below shows just how strongly the correlation can get, with the key turning points in price being aptly reflected on the other chart.

EURUSD (Top) and the US Dollar index (Bottom) (Courtesy: tradingview.com)
EURUSD (Top) and the US Dollar index (Bottom) (Courtesy: tradingview.com)

As you can see in the above chart, by adding an additional element of analysis, traders would be able to grow more confident in their analysis, at least as far as the EURUSD is concerned.

To learn more on how you can combine the technical analysis of the US Dollar Index, read through the following past analysis of the DXY and how the charts were able to give a broad picture of the price action in EURUSD.

To access the US Dollar Index for charting purposes, Right-click on ‘Market Watch’ and open the ‘Symbols’. Scroll to the CME Currencies group to find the USDIndex in your Orbex account.

Access US Dollar Index in your Orbex Account
Access US Dollar Index in your Orbex Account
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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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