Learn Trading for Free and Without Registration

An Online Glossary to Study Trading Independently

What is the Dollar Index?

US Dollar Index (USDX): What Is It and Why Is It Important?

If you are familiar with stock market trading, you have likely heard of indices like the Dow Jones Industrial Average (DJIA), NASDAQ Composite, Russell 2000, S&P 500, and Wilshire 5000. These indices provide a general overview of the stock market’s performance. However, in the currency market, the primary player is the US dollar, and its performance is tracked through the US Dollar Index (USDX).

What Is the US Dollar Index?

The US Dollar Index (USDX) is a measure of the value of the US dollar relative to a basket of six foreign currencies. It calculates the dollar's overall value in the global currency market using a geometric weighted average formula.

Similar to stock indices that represent the combined value of a basket of stocks, the USDX shows the status of the dollar relative to major world currencies. It is a crucial tool for assessing the overall strength or weakness of the dollar in the global economy.

Which Currencies Are Included in the Index?

The USDX comprises six currencies:

Euro (EUR) — 57.6%
Japanese Yen (JPY) — 13.6%
British Pound (GBP) — 11.9%
Canadian Dollar (CAD) — 9.1%
Swedish Krona (SEK) — 4.2%
Swiss Franc (CHF) — 3.6%

Why These Currencies?

These currencies represent the largest trading partners of the United States, and their weights in the index are determined by the volume of trade with the US.

How Many Countries Are Associated with the Index?

At first glance, it may seem like the index represents only six countries. However, it is actually linked to 21 countries:

16 countries in the Eurozone use the euro.
Another five countries — Japan, the United Kingdom, Canada, Sweden, and Switzerland — represent the remaining currencies.

While the USDX does not cover the entire globe, it represents a significant portion of the global economy.

Why Is USDX Important for Traders?

1. Measuring Dollar Strength

The USDX serves as a universal indicator of the current strength of the US dollar in the global market. A rising USDX indicates a strengthening dollar, while a falling USDX signals weakening.

2. Impact on Currency Pairs

The US dollar is either the base or quote currency in most currency pairs on the Forex market. The USDX helps traders predict movements in pairs like EUR/USD, USD/JPY, or GBP/USD.

3. Relationship with Commodities

The dollar strongly influences the prices of commodities like gold and oil, which are typically denominated in US dollars. An increase in USDX often leads to lower commodity prices, and vice versa.

How Is the US Dollar Index Calculated?

The USDX is a geometric weighted average of a basket of currencies. The weight of each currency in the index reflects its share of global trade.

Current Weight of Currencies in the USDX:

Euro (EUR): 57.6%
Japanese Yen (JPY): 13.6%
British Pound (GBP): 11.9%
Canadian Dollar (CAD): 9.1%
Swedish Krona (SEK): 4.2%
Swiss Franc (CHF): 3.6%

Why Does Euro Hold the Largest Weight?

The Eurozone comprises 16 countries, making the euro the most significant currency in the index. For this reason, the USDX is sometimes referred to as the "anti-euro," as its movement is often inversely related to the euro’s performance.

USDX and Its Connection to the Euro

The euro significantly influences the USDX due to its large share in the basket of currencies. When the euro weakens, the USDX typically rises, and vice versa. This makes the USDX a valuable tool for analyzing currency pairs where the euro is a component.

Are There Alternatives to USDX?

Some traders criticize the USDX for its heavy reliance on the euro and seek more balanced dollar indices. Here are a few alternatives:

Bloomberg Dollar Spot Index (BBDXY): Includes a broader range of currencies, providing better diversification.
ICE U.S. Dollar Index: Technically similar to the USDX but tradable on exchanges.

How Traders Use USDX in Their Strategies

1. As a Market Sentiment Indicator

Traders use USDX to gauge the overall direction of the dollar. For example:

If USDX rises, it may signal a decline in pairs where the dollar is the base currency (e.g., EUR/USD).
A falling USDX may indicate strengthening of base currencies against the dollar.

2. Predicting Commodity Prices

USDX is helpful for predicting the prices of gold, oil, and other commodities. Since these assets are denominated in dollars, their prices are inversely related to the index’s value.

Conclusion: Why Should You Know About the Dollar Index?

The US Dollar Index is a critical tool for evaluating the state of the global economy and understanding the dollar’s position on the international stage. It is widely used by traders to analyze currency pairs and forecast commodity prices.

Understanding USDX equips traders with the knowledge to make informed decisions, effectively analyze the market, and comprehend how global events impact currencies and financial markets as a whole.