Understanding the Dollar Index: An Essential Forex Analysis Tool

What Is the Dollar Index (USDX)

Dollar index (or USD Index, USDX, DXY) is a tool for measuring the relative value of the US dollar against a basket of major currencies in the global market. This currency basket includes the currencies of the United States’ largest trading partners, weighted according to actual trading volume.

This index is designed, managed, and published by ICE (Intercontinental Exchange, Inc.). It reflects fluctuations of the USD through a calculation formula based on major currency pairs. When the value of the dollar increases relative to other currencies, this index rises, and vice versa.

Composition of the Currency Basket in the Dollar Index

The index consists of 6 major currencies with different weights:

• EUR (Euro): 57.6% - the highest weight
• JPY (Japanese Yen): 13.6%
• GBP (British Pound): 11.9%
• CAD (Canadian Dollar): 9.1%
• SEK (Swedish Krona): 4.2%
• CHF (Swiss Franc): 3.6%

The high weight of EUR reflects the importance of the Eurozone in international trade and the global economy.

History of the Dollar Index

The dollar index was launched in 1973, shortly after President Nixon abolished the gold standard and allowed the US dollar to be freely valued on the foreign exchange market. Before this, under the Bretton Woods agreement (1944), the US dollar was fixed at an amount equivalent to one ounce of gold.

The initial base level of the index was set at 100. The highest historical level was recorded at 164.7200 in February 1985, while the lowest touched 70.698 in March 2008. These fluctuations reflect different economic phases of the US and the world.

Practical Applications: Correlation with Currency Pairs

$35 Inverse Relationship: EUR/USD

When the dollar index rises ###meaning the USD gets stronger(, the EUR/USD currency pair usually declines. This is because EUR accounts for 57.6% of the basket. When traders buy USD and sell EUR, the EUR/USD exchange rate decreases. This relationship is very reliable and widely used by analysts to forecast trends.

)Same Direction Relationship: USD/JPY

Contrary to EUR/USD, when the dollar index increases, the USD/JPY pair also tends to rise. This positive correlation helps traders confirm USD trend directions. When the dollar is strong, investors buy USD and sell JPY, causing USD/JPY to increase.

###Inverse Relationship: Gold Price

One of the most important applications of the dollar index is forecasting gold prices. When the USD index decreases ###meaning the USD weakens(, gold )XAU/USD( often rises. This is because gold is priced in USD, so when the dollar weakens, gold becomes cheaper for holders of other currencies, increasing demand.

Why Do Forex Traders Need to Monitor the Dollar Index?

The dollar index is a reliable indicator for analyzing forex market trends. By tracking its fluctuations, traders can:

Predict currency pair trends: When the dollar index rises sharply, USD-related pairs often face pressure. Traders can prepare suitable strategies such as selling EUR/USD or buying USD/JPY.

Identify commodity trading opportunities: Gold, silver, oil — commodities traded in USD — are closely linked to the dollar index. When USD weakens, demand for these commodities increases from holders of other currencies.

Improve analysis accuracy: Combining the dollar index with other technical indicators like moving averages or the Relative Strength Index )RSI( provides a more comprehensive market view.

How to Calculate the Dollar Index

The formula for calculating the dollar index is as follows:

USDX = 50.14348112 × EURUSD^-0.576 × USDJPY^0.136 × GBPUSD^-0.19 × USDCAD^0.091 × USDSEK^0.042 × USDCHF^0.036

In this formula:

• EUR and GBP are considered as the quote currencies )how many dollars one unit of currency is worth(, hence the negative exponents
• JPY, CAD, SEK, CHF are considered as the base currencies )how many units of currency one dollar can buy(, hence the positive exponents

However, traders do not need to perform these calculations manually. Modern forex trading platforms allow you to find this index using symbols: DX, DXY, or USDX.

How to Read and Interpret the Dollar Index

For example, on 20/9/2022, the dollar index closed at 105. On 21/9/2022, it moved up to 108, meaning the USD was stronger by 2.85% compared to the basket of major currencies yesterday.

Conversely, if the USD Index drops to 103, it indicates the US dollar’s value has decreased by 0.97% against the basket. These changes occur in real-time, enabling traders to seize short-term trading opportunities.

Related Terms Concerning the Dollar Index

Currency Basket )Currency Basket(: A collection of different foreign currencies, each with a specific weight depending on its importance in international trade. EUR currently has the highest weight, nearly 58%.

Broad Index of the US Dollar )Broad Index(: Created by the FED in 1998, this index measures the value of the dollar against the currencies of 26 countries and regions. The weights in this index change annually based on current trade models.

USDX Digital Currency: This is a completely different type of digital currency )similar to Bitcoin or Ethereum(, developed by Lighthouse on a blockchain platform. Do not confuse this digital USDX with the dollar index published by ICE.

Conclusion

The dollar index is an essential analytical tool for any forex trader. By understanding its mechanics, its correlation with currency pairs, and how to interpret its data, you can make more accurate trading decisions. Regularly monitoring its fluctuations and combining it with other technical analysis methods will help optimize your trading strategies in the forex market.