If you’ve traded stocks, you’re probably familiar with all the indices available such as the Dow Jones Industrial Average (DJIA), NASDAQ Composite Index, Russell 2000, S&P 500, Wilshire 5000, and the Nimbus 2001,... So what about the Forex market?
That's when USD Index speak its key role in determining market trends.
What Is The USD Index?
The U.S. dollar index (USDX), sometimes known as the USD index, calculates the value of the dollar in relation to a basket of world currencies. After the Bretton Woods Agreement was terminated in 1973, the US Federal Reserve created the USDX. ICE Data Indices, a division of the Intercontinental Exchange (ICE), is now responsible for maintaining it.
The six currencies that make up the USDX are frequently cited as being among America's biggest trading partners. The euro replaced the German mark, French franc, Italian lira, Dutch guilder, and Belgian franc in 1999, however, the index has only been revised once since then. As a result, the index is not a reliable indicator of current U.S. commerce.
History of The USD Index
The U.S. Dollar Index has risen and fallen sharply throughout its history. It reached an all-time high in 1984 at nearly 165. Its all-time low was nearly 70 in 2007. Over the last several years, the USD index has been relatively rangebound between 90 and 110.3.
Macroeconomic factors like recessions and economic growth in various nations, as well as inflation and deflation in the dollar and other currencies included in the similar basket, have an impact on the index.
Since the index's inception, the composition of the basket of currencies has only been altered once, in 1999, when the euro replaced many European currencies that had previously been included, including Germany's prior currency, the Deutschemark.
As the index aims to represent the main trading partners of the United States, it is possible that currencies may be substituted in the coming years. Given that China and Mexico are significant trading partners of the United States, it is expected that currencies like the Chinese yuan (CNY) and Mexican peso (MXN) will eventually replace other currencies in the index.
USD index 1: Bloomberg US Dollar Index (DXY)
- Currency Basket
Currently, the USD index is determined by taking into account the exchange rates of six different foreign currencies, including the euro (EUR), yen (JPY), Canadian dollar (CAD), pound (GBP), krona (SEK), and franc (CHF).
The euro is, by far, the largest component of the index, making up 57.6% of the basket. The weights of the rest of the currencies in the index are:
- Euro (EUR) - 57.6%
- Japanese yen (JPY) - 13.6%
- Pound sterling (GBP) - 11.9%
- Canadian dollar (CAD) - 9.1%
- Swedish krona (SEK) - 4.2%
- Swiss franc (CHF) - 3.6%
The index had a basis of 100 when it first began in 1973, and all subsequent numbers are in relation to this base. It was started soon after the Bretton Woods Accord was terminated. Participants in the arrangement paid their balances in dollars, which served as the reserve currency and was completely convertible into gold at a price of $35 per ounce.
Concerns about exchange rates and their connection to how gold was priced arose as a result of the overvaluation of the US dollar. When the gold standard was temporarily suspended by President Richard Nixon, other nations were free to pick any form of exchange rate other than the price of gold. The agreement came to an end in 1973 when several foreign governments decided to allow their currency rates to fluctuate.
- How to Trade the USDX
The USD index enables traders to keep track of the USD's value in relation to a group of chosen currencies in a single transaction. Additionally, it enables them to protect their wagers from any dollar-related dangers. On the USDX, futures or options trading strategies can be used.
Currently, the New York Board of Trade is where these financial products are traded. The index can be used by investors to speculate or hedge against broad currency movements. The index is also accessible indirectly through mutual funds or exchange-traded funds (ETFs).
The dollar index measures how the U.S. dollar compares to a basket of significant global currencies. If the index is increasing, the dollar's value relative to the basket is strengthening, and vice versa.
USD index 2: Bloomberg Dollar Spot Index (BBDXY)
The Bloomberg Dollar Spot Index (BBDXY) measures how a basket of 10 different world currencies performs in relation to the dollar.
Its composition is revised yearly and reflects a wide range of currencies that are significant in terms of international commerce and liquidity.
Let’s see how the Bloomberg Dollar Spot Index (BBDXY) outweighs the widely used ICE Dollar Index (DXY) by its pros:
- More representative: The Bloomberg Dollar Spot Index tracks a more representative basket of currencies by considering global currency market liquidity and trading partners of the U.S.
- More diversified: Unlike DXY, the Bloomberg Dollar Spot Index is NOT dominated by the euro. It also includes major emerging market currencies such as the Indian rupee, Korean won, Mexican peso, and Chinese renminbi which are all major trading partners of the U.S.
- More dynamic: Unlike the DXY’s static composition, BBDXY is dynamic, with an annual rebalancing process that captures the changing state of currency markets. This results in the index that includes important currencies (like the Australian dollar) that rank higher in liquidity and trading versus the Swedish krona.
To examine the Bloomberg Dollar Spot Index, run BDXY on the Bloomberg Terminal if you are a subscriber to Bloomberg. The live BBDXY quote is available on Bloomberg's website for free if you can't afford to pay the $20,000 yearly charge for a Bloomberg Terminal subscription.
On Bloomberg’s BBDXY page, you’ll see a live quote that looks like this:
Why Is The USD Index Important For Traders?
The USD Index is important for traders both as a market in its own right and as it is an indicator of the relative strength of the US Dollar around the world. It can be used in technical analysis to confirm trends related to the following markets, among others:
- Commodities priced in USD
- Currency pairs that include the US Dollar (such as the ones used to calculate the index’s value)
- Stocks and indexes.
As the value of the Dollar rises, commodity prices typically decline (at least nominally), and vice versa. Currency pairings, on the other hand, often move in the opposite direction of the Dollar Index if USD is the quote currency and the same direction if it is the base currency, however, these 'laws' are not always followed.
However, US exporters would typically find that their exports are less competitive when the Dollar is strong and more competitive when it is lower, with their share values frequently fluctuating to reflect fluctuations in the Dollar's value. The situation is more complicated for stocks and indexes.
Many traders also use the index to hedge risk – for example, offsetting some of the risk associated with a long USD/JPY trade by going short on the Dollar Index.
How To Use USD Index In Trading
The US Dollar Index can be traded using futures and options or, where permitted, spread betting and CFD trading can also be used to speculate on whether the USDX will go up or down in price. To use the US Dollar Index, you can:
- Add some funds so you can start trading instantly.
- Search for “USD Index” in the web platform or mobile app.
- Hit ‘buy’ to take a long position, or ‘sell’ to go short.
Alternatively, you can trade the US Dollar Index using futures and options or, where permitted, spread betting and CFD trading. The USDX can be used as a proxy for the health of the U.S. economy and traders can use it to speculate on the dollar's change in value or as a hedge against currency exposure elsewhere.
The value of the dollar relative to a basket of six different foreign currencies is determined by the USD Index. The index was created with a base of 100 shortly after the Bretton Woods Agreement was terminated in 1973, and values since then have been related to this base. The index's value provides a reliable representation of the dollar's value on international markets.
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