Understanding the USDX

04/07/2014 9:00 am EST

Focus: CURRENCIES

Mike Kulej of FXMadness.com explains what the US Dollar Index is and why most forex traders, as well as other kinds of traders, closely watch its movements.

The USDX or the US Dollar Index is an index that was set up in 1973. It is a measure of the value of the US dollar relative to majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies. The USDX is traded mainly in futures or options trading accounts and is treated like any other commodity such as corn, oil, and even gold, as well as a currency. Many traders view it as a powerful indicator of the condition of the US dollar.

How is the USDX Calculated?
The USDX measures the value of the United States dollar relative to a basket of foreign currencies. The main currencies that it is compared to include the euro, the Great Britain pound, the Japanese yen, the Canadian dollar, the Swedish krona, and the Swiss franc. The makeup of the "basket" has been altered only once, when several European currencies were subsumed by the euro at the start of 1999.

The comparison is on a weighted basis, with the maximum weight currently given to the euro. This is why many forex traders feel that the USD/EUR currency pair tends to mimic those of the USDX. At the same time, the USDX is a better indicator of the strength of the US dollar since it compares the value to other currencies as well.

Reading the USDX
When the USDX was established in 1973, it was given a value of 100. So when the USDX has a value higher than 100, it means that the US dollar is stronger than what it was in 1973. When the USDX is lower than 100, it means that it is weaker than what it was in 1973. For example, if the USDX is at 82, it means that it is 18% weaker than what it was in 1973. If it has a value of 120, it would suggest that the US dollar experienced a 20% increase in value over the time period.

What is the USDX Used For?
USDX is updated whenever US dollar markets are open, which is from Sunday evening New York time (early Monday morning Asia time) for 24 hours a day to late Friday afternoon New York time.

The USDX is used by all kinds of traders, including those who trade in bonds, currency markets, and gold markets. This is because the USDX is correlated to the various markets in different ways. For example, the gold markets are closely related to falling gold prices. Therefore, even traders that do not trade in the USDX and trade in gold, keep a close eye on the manner in which this index moves. Bond yields drop when there is a global crisis as the demand for the USD increases manifold. This is why bond traders keep track of the USDX as well. At the same time there are many traders that trade in futures and options available on the USDX. This is a direct trade that some investors prefer.

The USDX is just one of the various indicators that forex traders employ in order to understand the trends in the forex markets. It is an easy indicator to follow for all those interested in the US dollar.

By Mike Kulej of FXMadness.com

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