By Nathan Boardman
Based on the results of the 2019 Triennial Survey of turnover in over-the-counter foreign exchange markets, the United States dollar continued to hold its position as the most extensively utilized currency, with around 88 percent of all deals using it. In addition, according to the International Monetary Fund (IMF), more than sixty percent of the reserves of foreign currency are stored in dollars.
The United States dollar is included in the currency pairings that are traded often. In addition, the United States dollar now holds the position as the principal currency in the commodity market, which means that it has a direct impact on commodity pricing.
The United States Dollar Index: What Is It?
Most traders are proficient in applying support and resistance levels on charts and are familiar with reading technical indicators, such as RSI. The US dollar index is another noteworthy tool to consider.
Created in March 1973, the US dollar index, also known as the ‘DXY’ or ‘USDX,’ gauges the US dollar’s worth compared to six significant currencies.
In terms of weighting, the euro (EUR) is the most significant, accounting for around 57.6% of the total. Immediately following the JPY with a share of 13.7% is the GBP, which comes in a close second with 11.9% of the market share. The CAD holds a respectable 9.1% of the market, while the SEK and CHF are in second and third place, respectively, with 4.2% and 3.6% of the market share.
Over the course of its existence, the index has experienced record highs of 164.72 and record lows of 70.69. If you are familiar with major stock indexes such as the DJIA, the S&P 500, and the FTSE 100, you will notice that the DXY acts similarly to these indices; however, it is more concerned with currencies than it is with stocks.
What Are the Reasons That Traders Should Pay Attention to the US Dollar Index?
The US Dollar Index holds excellent significance for traders, providing valuable insights into the strength of the US Dollar on a global scale. It is applicable in technical analysis to validate trends associated with various markets, among others:
- Commodities valued in US dollars
- Forex pairs that incorporate the US Dollar (like the ones utilized to determine the value of the index)
- Equities and market indicators.
Commodity prices tend to decrease (at least in terms of their nominal value) when the Dollar strengthens – and the opposite is also true. When it comes to currency pairs, they tend to follow the same trend as the Dollar Index if the USD is the base currency. However, if it is the quote currency, they usually move in the opposite direction. It’s worth noting that these patterns don’t always remain consistent.
When it comes to stocks and indexes, the situation becomes more intricate. US exporters typically discover that their exports face less competition in the global market when the Dollar is robust, while they become more competitive when the Dollar is weaker. Consequently, their stock prices tend to fluctuate in response to shifts in the Dollar’s value.
Traders often utilize the index to mitigate risk, such as balancing the potential drawbacks of a long USD/JPY trade by taking a short position on the Dollar Index.
Making Use of the DXY
The strength of the USD may be measured by looking at the DXY.
- Currency pairings that use the US dollar as their foundation currency, like USD/CHF, might be attractive possibilities for buying if the DXY is oversold. Similarly, when the DXY is bought up too much, the idea of selling those markets becomes appealing.
- When the DXY appears to be overbought, a strategy of buying EUR/USD or GBP/USD currency pairings, where the USD is the currency being quoted, could be a more appealing option. Conversely, if the DXY signals weakness, traders may consider selling these assets.
What constitutes oversold and overbought circumstances is subjective and depends on the trader’s point of view.
More Tools
You are free to use any method that will help you identify whether the DXY is overbought or oversold. Traditional ideas of supply and demand, as well as trend lines, are optional.
It is crucial to comprehend where the DXY is at the moment. It makes trading setups more critical.
Feel free to experiment with different types of technological tools. Instead of depending only on price action, technical indicators work better for detecting overbought and oversold situations for DXY.
