As we have been trading indices, you’re probably familiar with Dow Jones Industrial Average (DJIA), NASDAQ Composite Index, Russell 2000 and S&P 500.
So, if U.S. stocks have an index, the U.S. dollar has the U.S. Dollar Index (USDX).
The U.S. Dollar Index consists of a geometric weighted average of a basket of foreign currencies against the dollar. It’s very similar to how the stock indices work in that it provides a general indication of the value of a basket of securities (currencies)
The U.S. Dollar Index consists of six foreign currencies. They are the:
1. Euro (EUR)
2. Yen (JPY)
3. Pound (GBP)
4. Canadian dollar (CAD)
5. Krona (SEK)
6. Franc (CHF)
Do note that the index is made up of 6 currencies, but there are more than 6 countries involved. Total is 24 because there are 19 members of the European Union that have adopted the euro as their sole currency, plus the other five countries.
It’s obvious that 24 countries make up a small portion of the world but many other currencies follow the U.S. Dollar index very closely. This makes the USDX a pretty good tool for measuring the U.S. dollar’s global strength.
Below is the composition of the US Dollar Index. With its 19 countries, euros make up a big chunk of the U.S. Dollar Index. The next highest is the Japanese yen, which would make sense since Japan has one of the biggest economies in the world. The other four make up less than 30 percent of the USDX.
Image extract of google image
First, notice that the index is calculated 24 hours a day, five days a week. Also, the US Dollar Index (USDX) measures the dollar’s general value relative to a base of 100.000.For example, the current reading says 86.212. This means that the dollar has fallen 13.79% since the start of the index. (86.212 – 100.000).
If the reading was 120.650, it means the dollar’s value has risen 20.65% since the start of the index. (120.650 – 100.00)
In the wide world of forex, the USDX can be used as an indicator of the U.S. dollar’s strength.
Because the USDX is comprised of more than 50% by the euro zone, EUR/USD is quite inversely related. If one goes up, the other most likely goes down. This could be a big help to those big on trading EUR/USD.
To sum it all up, forex traders use the USDX as a key indicator for the direction of the USD.