While most traders do not trade the U.S. Dollar Index (USDX) it can be a useful tool for trading other currencies. At times it may be a missing piece to your trading puzzle so it pays to understand ways you can use it to trade.
What Is the U.S. Dollar Index (USDX)?
According to Investopedia, the U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to a basket og currencies. The USDX was established by the U.S. Federal Reserve in 1973 after the dissolution of the Bretton Woods Agreement. It is now maintained by ICE Data Indices, a subsidiary of the International (ICE).
Which currencies are in the USDX basket.
There are six currencies in the basket, Euro, British pound, Japanese Yen, Swiss Franc, Canadian dollar and Swedish kronor. Note the USDX was reconfigured in 1999 when the Euro replaced the Deutschemark, French franc, Dutch guilder, and Belgian franc.
USDX basket weightings
EUR 57.6%
JPY 13.6%
GBP 11.9%
CAD 9.1%
SEK 4.2%
CHF 3.6%
Is the USDX a good measure of the US dollar’s value
There was a time when the forex trading world was dollar-centric. This meant that most times all currencies moved in the same direction vs. the dollar but at different paces. In the current cross-currency trading world, this has changed. The USDX is not as good a measure of the dollar’s value as currencies can often move in opposite directions, such as the Eur vs the JPY.
However, this does not mean it is not a useful tool for trading. If you look at the basket and the respective weightings, three currencies stand out as generally moving in the same direction vs. the dollar, the EUR, GBP and CHF. These comprise 73% of the USDX’s value with the EUR having by far the largest share.
How to use the USDX for trading
To sum up, while the USDX can give a clue to the directional risk in the dollar, especially those times when all currencies are moving in the same direction, it seems to be better suited to act as a proxy for the EURUSD. With the three currencies mentioned totaling 73% of the USDX, and the EUR weighting at 57.6%, one can make a case that USDX is more of a reflection of the EUR than the USD…As I like to say, knowledge is power and USDX can be another piece of your trading puzzle, even if you don’t trade it directly
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