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Using The USDX When Trading The Dollar

For traders, the U.S. Dollar Index (USDX) is an important tool used for analysis in most markets. The USDX functions as a futures contract, meaning you can use your futures trading account and trade this instrument much like others futures contracts, such as gold, corn, oil, or currency. Instead of trading, retail traders typically use the USDX as a method to analyze the strength of the U.S. dollar (USD).

For analytical purposes, the USDX makes a comparison between the USD and other global currencies. Included in this comparison are most of the free-floating major currencies worldwide and they are weighted based on averages. Among the currencies included in the comparison are the Swiss franc, British pound, Swedish krona, Canadian dollar, yen, and euro. Each currency is weighted within this index. The euro is given the largest weight.

dollar index
On the chart for the USDX, the euro is generally half of the total weight in the average. The chart often looks akin to a USD/EUR futures contract. It is apparent to spot forex traders that there is a similarity between the USDX and inverse of the spot forex pair EUR/USD. Since the USDX contains six currencies, its measurement of the USD strength is better than a single currency pair, such as EUR/USD.

In 1973, the USDX was initiated with a beginning value of 100. If the USDX were to have a measurement below 100, then it would mean the USD was valued less than its worth back in 1973. However, if the value is greater than 100, the USD would be stronger than its value in 1973. Now, the USDX is approximately 82, meaning it is about 18% weaker than it was in 1973. The USD was not always weaker than when it started. In 2001 and 2002, the USDX had a 20% improvement in value for the USD.

Traders in gold, bonds, and currency markets find the USDX is quite useful. In general, when the USD is strong, it correlates will decreased gold prices. A break out on the USDX would be of interest to gold traders, even if they were not directly trading the USD. Global crises also increase the demand for the USD, because investors seek protection from doubt. This will increase the value of the USD and bond yields typically drop. Those are two ways in which the USDX can be used as an inter-market tool to assist in evaluating capital flows and finding new opportunities for trading.

The USDX chart contains a pairs analysis page, which is located in the forex section on the Learning Markets site. If you want to trade the USDX, there are two additional alternatives that are also attractive. First, consider opening a futures account. Both futures and options for futures are available on the USDX and they trade on the NY Board of Trade.

Next, consider trading ETFs that can track the USDX. PowerShares is one option and they offer two ETF alternatives used for the trading index. One is UUP, which is used for investments in long futures contracts on the USDX. This means it moves with the dollar index, if the dollar index increases so does the UUP. The other is the UDN, which is for short futures contracts on the USDX. It works in the opposite manner; it will increase as the dollar index decreases. Buy UUP if you are bullish, whereas you would buy the UDN if you are bearish.

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