The US Dollar Index (DXY) measures the value of the dollar against a basket of six major currencies, based on the exchange rates of these currencies. The index was created as an indicator of the weakness or strength of the U.S. dollar relative to other currencies. It is considered as a guiding tool to buy or sell currencies, especially the US dollar pairs, in the forex market.
The US Dollar Index
The dollar index commonly abbreviated DXY, measures the value of the United States Dollar relative to six major currencies which are the Euro, Japanese Yen, Canadian Dollar, British Pound, Swiss Franc, and the Swedish Krona.
The Euro is the most significant currency in the dollar index accounting for 57.6% of the basket. The Japanese yen (JPY) contributes by 13.6%, followed by the British Pound (GBP) by 11.9%, the Canadian Dollar (CAD) by 9.1%, Swedish Krona (SEK) by 4.2%, and finally the Swiss Franc (CHF) by 3.6%.
The currency basket has been modified once since the creation of the index. In 1999, the euro replaced many European currencies previously in the index, such as the Deutsche Mark, the previous currency of Germany. Other changes may be applied to the index in the coming years as currencies of major trading partners of the United States are expected to replace some of the existing currencies. The Chinese Yuan and Mexican Peso are highly nominated to be included in the index.
History of the Dollar Index
The dollar index was first created by the Federal Reserve in 1973 to track the value of the dollar after the collapse of the Bretton Woods Agreement and the abandoning of the gold standard. That allowed the value of the dollar to float freely after being fixed at $35 per ounce of gold under the Bretton Woods Agreement.
Since then, the Index has provided a method for markets to establish the globe’s reserve currency value.
The dollar index all-time high was recorded at 163.83 on March 5, 1985. While the all-time low was 71.58 on April 22, 2008. The index was launched at 100, the base value of the dollar.
The Intercontinental Exchange (ICE) has managed and owned the index since 1985.
The difference between USDX, DX and DXY
The three abbreviations are used to refer to the US Dollar Index. The USDX usually refers to the original dollar index. The DX is the symbol used by the ICE Exchange for the futures contracts, it is usually followed by the month and code. The DXY is the most popular symbol for the dollar index, sometimes referred to as Dixie.
The US Dollar futures contracts are being traded on the ICE platform. The size of one US Dollar Index future is $1000 times the index value.
Why is the Dollar Index important for FX Traders?
FX traders are watching the Dollar Index gauge and monitor the value of the Greenback against major currencies. If a trader is convinced the Dollar will appreciate relative to its counterparts, it might be simpler to place a single trade betting on a rising US Dollar Index instead of opening multiple forex positions. It also can be used to detect the direction of the USD currency pairs.
What affects the Price of the Dollar Index?
The price of the dollar index is influenced by macroeconomic events and data, such as GDP economic growth, Inflation, and monetary and fiscal policies. Interest rates impact the value of the dollar directly. Higher interest rates make the USD more attractive to investors, which leads to an increase in the value of the index. On the contrary, when the market starts to price in lower interest rates, the index comes under pressure.
Another major influence on the Dollar index’s price is the safe-haven inflows. Because the greenback is seen as a safe-haven currency, the index rises during periods of uncertainty as investors turn to the USD as a value store amid global crises. The index may fall in times of high-risk appetite and sentiment as investors sell off the USD for the sake of riskier assets.
How to trade the Dollar Index?
The US Dollar Index can be traded just like an equity index. Rather than trading several USD pairs, you can simply trade one index according to the overall market sentiment, economic conditions, and policy stances. The index has gained its popularity among FX traders as a gauge of the value of the dollar against other currencies, helping traders to analyze more currency pairs using only one tool. Due to the high volumes of trading, the spreads or commissions for the DXY can be competitive.
You can adjust your trading positions based on whether the index is up or down. For example, if the index is bullish, you can buy USD/JPY and USD/CHF pairs or sell the EUR/USD and GBP/USD pairs.
Both technical analysis and fundamental analysis can be easily applied to the DXY while trading. However, you should pay attention to major factors like interest rates, monetary policy decisions, and market risk mode.
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