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US Dollar Index – A EURUSD Trader’s Best Friend!

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Summary:

  • EURUSD is one of the most popular and liquid trading instruments in Forex
  • With tight spreads, FX traders can dedicate themselves to trading just the EURUSD currency pair by combining the US dollar index technical analysis
  • In this article, you can find some new and unique ways to spot trade set ups in EURUSD, by combining the US dollar index analysis as well.

One of the key factors that determine your long term success in FX trading is in picking your trades. It is not surprising then that the phrase ‘high probability’ is often used in a trading system. High probability simply refers to the fact that the trade setup has been known to perform well and thus improves the odds of the trade achieving its target price.

There are many different ways and methods to pick the high probability trade set ups, and this can vary from one trading strategy to another.

For EURUSD FX traders, additional confirmation to their trade setups can be made by looking at the US dollar index chart. At Orbex.com, the US dollar index is available as a charting instrument and goes by the name USDIndex. Using the information from the US dollar index can offer great insights into your EURUSD trades that you might have previously missed. For those wanting to know more about the US dollar index, this article offers a detailed background into the components of the US dollar index.

How can the US dollar index help EURUSD traders?

With the Euro currency taking the biggest weight in the dollar index basket, it is not surprising that the price action in the US dollar index tends to affect the EURUSD currency pair the most. The chart below shows the EURUSD (top) and the US dollar index (bottom) shown for comparison. If you look closely, it is easy to understand how the price action (candlestick patterns, trends) are closely correlated.

US Dollar Index and EURUSD Chart for comparison
US Dollar Index and EURUSD Chart for comparison

Notice the (inverse) correlation in the two charts, which includes not just candlestick patterns but also support and resistance lines, trend lines and even your own trading strategies that can be applied to both the US dollar index and the EURUSD chart.

It should be obvious by now that using the US dollar index and analyzing the chart, in addition to the EURUSD analysts can offer more confidence in your trade set ups. From comparing the two charts based on a trading strategy or even looking at the individual candlestick patterns, FX traders can make better trading decisions when using both charts together. The chart below shows a simple median line analysis on the EURUSD and the US dollar index. Given the inverse relationship between the two currency instruments, FX traders are able to trade the median line set up with a lot more confidence, than applying just the EURUSD analysis alone.

Technical Analysis on EURUSD (left) and the Dollar Index (Right)
Technical Analysis on EURUSD (left) and the Dollar Index (Right)

Getting started – EURUSD and US Dollar Index Analysis

Using the two instruments to analyze the price action in EURUSD is quite simple. The following tips should help you get started right away.

  • If you have a trading strategy or a method, then apply the same to both the EURUSD and the US dollar index. Look for confirmation (opposite confirmations) before you ta ke up the trade
  • Daily charts or H4 charts are ideal timeframes you can use to analyze both the charts. Although you can still technically use the H1 timeframe or lower
  • Some of the best trading setups come from looking at the candlestick patterns. For example, if you see an inside bar or a bullish/bearish engulfing on US dollar index chart, but the pattern is not clear on EURUSD, you could make use of this information to trade the EURUSD accordingly (refer to the chart below)
EURUSD (Top) and US Dollar Index (Bottom) – Session by session comparison
EURUSD (Top) and US Dollar Index (Bottom) – Session by session comparison

Trading ranges with US Dollar Index and EURUSD

The above section covers the typical methods of combining the US dollar index and the EURUSD. However, there is another interesting way to combine both these instruments, which is known as ‘Trading Range’.

What’s interesting about the ranges is that when you overlay both the instruments, you will often find that the high or low established by one instrument is respected by the other. The chart below illustrates this view. The black line depicts the EURUSD, and the blue line depicts the US dollar index.

When a new high is formed, you can be sure that the other instrument will most likely form a new low as well. Mark these points on the chart but instead of using the price of the instrument, flip the price over.

For example, in the chart below EURUSD made a high to 1.15294. Instead of using this price level as a high, look to the corresponding dollar index price (which is approximately 97 – 97.50). Likewise, when US dollar index makes a low to 92.50 – 92.75, mark this low to the corresponding EURUSD price which is 1.099 – 1.10. Now closely observe the price action after the vertical line. You can see how the blue line (USDX) rallies all the way to 97 – 97.50 (previous high marked by EURUSD) and reverses, and conversely, the black line (EURUSD) falls to 1.099 – 1.10.

With the ranges now established and also knowing beforehand how prices will react and the possible price targets, traders can then apply these levels on the EURUSD chart and trade in the direction, knowing very well where to book their profits or where to enter a new trade from.

Range Trading with EURUSD and Dollar Index
Range Trading with EURUSD and Dollar Index

Conclusion

As illustrated above, combining and using the information from the US dollar index alongside the EURUSD can provide FX traders unique insights that can be missed when Forex trading EURUSD in isolation. In the Forex markets, a successful trade is one where an FX trader has information about something that the rest of the market participants are yet to latch on to.

Start using the US dollar index as part of your EURUSD analysis and spot some really unique and interesting trade setups that could be otherwise missed.

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