The US dollar is one of the most traded currencies in the forex market. And the US dollar index is a measure of sentiment towards the US dollar versus the other major currencies. In technical terms, the USDX measures the value of the US dollar versus a basket of other currencies. These currencies are used by major trading partners of the United States. The index reflects the strength of the US dollar. So, the USD index will rise if the dollar gains vs. the other currencies. And it will fall if it shows weakness.
What dollar index means?
The US dollar index measures the value of the USD against a basket of other currencies. This pool of currencies includes the Euro, Japanese yen, Swedish Krona, British pound, Swiss franc, and Canadian dollar. The result is a good indication of the strength of the US currency in markets around the world. Read on to see how to calculate the USD index.
For forex traders, the US dollar index is available for trading as a futures contract. But this is only available through ICE or the Intercontinental Exchange. It is also available for options trading. You can also trade it as ETFs (exchange-traded funds) or CFDs (contracts for difference) if your market or local regulator will allow it.
If you are wondering when the dollar index began, it was created in 1973 by the US Federal Reserve. Today, it gets managed by ICE Futures US, Inc., one of the largest exchange groups in the world. It is a private company that operates thirteen exchanges worldwide, including the New York Stock Exchange. Starting in 1985, the Federal Reserve designated ICE as the caretaker of the US dollar exchange. It compiles, manages, and calculates the value of the dollar index. Forex enthusiasts who want to trade the US dollar index can do so only through the ICE trading platform.
What is the history of the US dollar index?
Previously, the measurement of the value of a currency is through the gold reserves of the country. But in 1944, the Breton Woods agreement was established that replaced the gold standard with the US dollar standard. The countries agreed to use the US dollar since three-fourths of the world’s supply of gold was with the United States of America.
In 1973 the Breton Woods agreement ended. And the creation of the US dollar index happened as countries continued to benchmark their currencies against the dollar. The US dollar continued to serve as the reserve currency of the world economy. The index started with a base value of 100. The index value moves up or down relative to this base.
The currencies in the basket have changed only once since 1973. It happened in 1999 when several European countries adopted the Euro as their unified currency. But it did not affect the positions held by the five major trading partners of the US in the European Union. Germany, France, Italy, the Netherlands, and Belgium keeps their value share in the basket of currencies.
In the future, we expect that there will be another movement in the currency basket used in the USDX. As the Chinese economy and influence grow, it will have a bigger impact on the US. Especially in the import and export industries. And since the basket of currencies represents countries with trading relations with the US, it is not surprising to see the Chinese yuan in that pool. Soon. Very soon.
Another strong contender is the Mexican peso. As a friendly neighbor who shares the border with the US, trade with Mexico has never been more active. And as both countries develop their economic ties better, the peso will be in a better position to join the basket of currencies used in the dollar index.
What is the dollar index today?
As of August 20, 2020, the US dollar index is at 93.42. It means the dollar value dropped more than 6% relative to the currencies in the basket that we identified earlier. But compared to the day before, this is .30% higher.
The highest dollar index happened in February 1985 at 164.72. It means the dollar value increased almost 65% compared to the six currencies in the basket. In contrast, the lowest was back in March 2008 at 70.698. During this time, the dollar value decreased by more than 29%.
The dollar index swings up and down depending on a lot of factors. It includes macroeconomic indicators such as GDP growth, economic growth, and the fiscal policies adopted and implemented by individual central banks of the countries in the basket of currencies.
Some of the milestones in the US dollar index movements came from economic performance. And also from liquidity concerns. In the 1990s, the index went up after a trade surplus from current accounts. But in the 2000s, it fell sharply with the increase in the national debt of the US. Afterward, it recovered in 2008 during the Great Recession as investors took advantage of the safety of the US dollar.
Is the US dollar up or down today?
There are two ways of reporting the dollar performance today. If we compare the value of the dollar today versus its value yesterday, then we can say that the US dollar is up today. The dollar is now trading at .30% points higher vs. the previous day. The US dollar index now stands at 93.42.
Another way of looking at the data is by comparing the value of the dollar versus the other currencies in the basket. Based on the index of 100, the dollar is down today by 6%. So, the dollar is generally weaker against the other currencies in the basket today.
Since there are different ways of interpreting the same data, you must be careful as misinformation will affect your trading decisions. It will also affect your trading strategies and the specific triggers you use for your trading positions. And in the end, it will spell the difference between gaining profit or losing money.
How is the US dollar index calculated?
The dollar index is computed based on a weighted value relative to the six currencies in the basket. The Euro has the largest share and accounts for 57.6% of the value of the total basket. If you are wondering how come, we will need to look back at some historical data. It is a time before the Euro came into existence. The basket of currencies represents countries that are major trading partners of the United States of America. In Europe, this includes countries like Germany, France, Italy, the Netherlands, and Belgium. In total, these five countries in Europe and their currencies were part of the basket of currencies used in benchmarking the strength of the US dollar. Now that they use Euro as their common currency, these countries retained the weighted value they had before. And this totals to 57.6% all of which are assigned to the Euro.
Here are the different currencies in the basket and their weighted value.
- Euro (EUR) at 57.6%
- Japanese yen (JPY) at 13.6%
- British pound (GBP) at 11.9%
- The Canadian dollar (CAD) at 9.1%
- Swedish Krona (SEK) at 4.2%
- Swiss franc (CHF) at 3.6%.
Why is the US dollar index important?
The US dollar index is a trading instrument by itself. You can trade based on the movement of the dollar index value over time. But if you choose to do trading in USDX, you need to create a trading account with ICE, or the Intercontinental Exchange Group. It can be a challenge if you already have a brokerage firm for your other trading investments. It will not be possible to consolidate your investment portfolio into one broker. That is unless you move everything to ICE. If you do, take time to get to know them, backcheck their reputation, and be clear on the kind of support they provide. You will also need to study their fees and commission schemes to ensure that you get the most out of the services they provide. In addition, you must use the ICE trading platform. It will take some time for you to get yourself familiar with this system. And you will have to create or test your existing trading strategies to make sure that it works fine with this platform. Also, check if they are operating in your country and the regulation that governs their operations in your country.
If you are a forex trader who chooses the US dollar in your currency pairings, the dollar index will prove to be very useful for you. When you open several trading positions with different currency pairings, you will have to monitor each one consistently. It demands a lot of time and effort on your part. But by using the dollar index, you can get an indication of the strength of the US dollar across different currency pairings in a single US dollar index chart. Imagine the hours you can save each day! It is time you can use to do other more important things. For example, your well-being. And family bonding time.
The dollar index can also serve as an indicator of trends in the commodities market. The general observation is that commodity prices decrease when the US dollar increases in value. Also, during recessions and economic hardships, traders tend to move their money from general commodities to the US dollar. The reason is that the dollar keeps its strength during difficult economic times as they have done in the past years.