The US Dollar Index enables traders to monitor and trade one of the strongest currencies in the world, Dollar, relative to several foreign currencies in the US trade basket.
Whenever the US Dollar appreciates against these currencies, the index’s price increases and provides traders more significant trading opportunities. In this article, we discuss everything about the Dollar Index.
Understanding the US Dollar Index (USDX)
The US Dollar Index measures the US Dollar value relative to the other foreign currencies’ values. The currencies against which the US dollar value is measured belong to America’s major trading partners. These currencies are Euro, Canadian Dollar, Swiss Franc, British Pound, Japanese Yen, and Swedish Krona. The weights belonging to the other currencies are:
- Euro 57.6 percent
- Japanese Yen 13.6 percent
- British Pound 11.9 percent
- Canadian Dollar 9.1 percent
- Swedish Krona 4.2 percent
- Swiss Franc 3.6 percent
The currencies in the Index can be replaced as and when the US trading partners change. This is because the basket is flexible and solely represents the major trading partners of the US.
The value of the US Dollar Index indicates the Dollar’s value in the global markets. If the US Index’s value increases, it indicates the US Dollar strengthening, and if the Index’s value decreases, it indicates the US Dollar’s value decreasing.
The US Dollar Index is impacted by macroeconomic factors like inflation, economic growth, recession, and deflation in the US and other countries.
Depending on your time zone, you can trade the US Index Dollar from Sunday to Friday, 21 hours a day. According to Eastern Standard Time, the market opens from 20:00-17:00. The Greenwich Mean Time trading hours operate from 01:00-22:00, and the Singapore Standard Time zone trades from 09:00-06:00.
How is the Dollar Index calculated?
The geometrical average of all the six currencies that form the basket is calculated to compute the value of the Dollar Index. The midpoint value (average) of each currency’s bid and ask price at that point in time is multiplied by its given weightage and divided by six to determine the Index’s value up to three decimal places. The index value is calculated every 15 seconds in real-time.
For example, let us assume the average of bid and ask price of each currency is 1, the value of Index will be calculated as –
1 (57.6%) + 1 (13.6%) + 1 (11.9%) + 1 (9.1%) + 1 (4.2%) + 1 (3.6%) / 6 = 0.167
Factors affecting the US Dollar Index
1. Market supply and demand
The demand for the Dollar increases whenever the US exports its products and services. This is because exporting from a country requires customers to pay in USD. The conversion of local currency into Dollars appreciates the USD in the forex market and the value of the US Dollar Index. However, whenever the US imports products and services, it converts its currency into a foreign currency, which leads to depreciating the value of the Dollar. This leads to a weakening of the US Dollar Index.
2. Economic factors
Economic factors like the GDP of the US, inflation, wage policies, and employment rate, affect the US Dollar Index as well. When the GDP of the country increases or the inflation is stable at a low rate, the US Dollar strengthens in the forex market compared to other currencies, and so does the US Dollar Index.
On the other hand, if the US economic factors are not positive, the value of the currency is negatively impacted in the forex market, decreasing the value of the US Dollar Index.
3. Market sentiment
In situations where the economy of the US weakens due to factors like a decrease in consumption or increase in unemployment, the US economy is forced to sell off the money raised from bonds and government stocks to repay the local currencies. This leads to a decrease in the value of the US Dollar Index. On the contrary, when foreign investors push money back into the economy as the economy flourishes, consumption increases and unemployment decreases, leading to the US Dollar Index strengthening and increasing in value.
How to trade the Dollar Index?
1. Contract for Differences (CFDs)
A Dollar Index CFD allows you to trade the Index without actually owning it. You sign a contract with the broker who enables you to buy as many units of the Dollar Index as you wish and sell them at a later date. The amount paid is the difference between the opening and closing price of the Dollar index.
Dollar Index Options can be traded by opening an options trading account. After choosing how many units of the Dollar Index you want to purchase, you predict the future price of the option at which you will buy the options at a predetermined date. With Dollar Index Options trading, you are not obligated to buy the security, and if the expiration date passes, the option becomes invalid.
Dollar Index futures are a type of contract where you predict the future buying price of the Index at a predetermined date. In this contract, you are obligated to execute the buy order at the fixed date. If you wish to exit the contract before the expiration date, you can do so by either selling the contract to someone else or opening an equal-value contract opposite to the original one, at the same predicted price and expiration date.
4. Exchange Traded Funds (ETFs)
Dollar Index ETFs track the Index’s prices from time to time, and hence the price of ETFs fluctuates all the time during a trading day. They are highly liquid due to the high demand and supply of ETFs and can be closed at any point in time. The two most important Dollar Index ETFs to track are UUP and UDN, which consists of several currencies along with the US Dollar.
- UUP ETF longs the US Dollar prices and shorts the other currencies in the Dollar Index basket through US Dollar Index futures
- UDN ETF tracks all value changes in the foreign currencies relative to the USD through US Dollar Index contracts
Track the value changes in the USD and USDX today
You can track the fluctuations in the USDX by keeping a close eye on how the US Dollar fluctuates in the foreign exchange market. Any appreciation in the currency increases USDX’s value, and any depreciation in the same decreases USD’s value.