What is the DXY index? How to apply the USD Index in Forex analysis

USD Index - A Tool to Measure the Strength of the US Dollar

The US dollar index, also known as USD Index (USDX, DXY), is an index used to evaluate the value of the US dollar against a basket of major currencies from the largest trading partner countries with the United States. When this index rises, it indicates that the USD is strengthening in value relative to other currencies. Conversely, when the index falls, the USD is weakening.

Structure and Components of DXY

Managing Organization: ICE (Intercontinental Exchange, Inc.) is the entity responsible for designing, maintaining, and publishing the USD Index on the international market.

Currency Basket Components are weighted as follows:

• EUR (Euro): 57.6%
• 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%

History and Benchmark: The index was launched in 1973 with a base level of 100. The highest recorded level was 164.7200 in February 1985, while the lowest was 70.698 in March 2008.

The Role of the USD Index in Forex Trading

###Correlation with Currency Pairs

When DXY increases, it reflects a strengthening US dollar. In this case, currency pairs containing USD will move in two different directions:

Inverse currency pairs (such as EUR/USD): When the DXY rises, the EUR/USD exchange rate tends to decrease. This occurs because investors sell EUR to buy USD, reducing the value of EUR against USD.

Same-direction currency pairs (such as USD/JPY): When DXY increases, the USD/JPY rate also rises. Traders buy more USD and sell JPY, causing the USD to appreciate against the Yen.

###Correlation with Commodity Markets

The USD Index also has an inverse correlation with gold (XAU/USD). When the USD weakens, the DXY decreases, prompting investors to sell USD to buy gold, which drives gold prices up. Assets like oil and silver are similarly affected.

Why Traders Need to Monitor the DXY

The USD Index is a reliable indicator for forecasting the trend of Forex exchange rates. By analyzing DXY fluctuations, traders can:

• Identify dollar trends: When DXY surges, it signals that the USD is favored, creating buying opportunities for USD-related pairs.
• Analyze commodity markets: Analysts use DXY to assess the momentum of gold, silver, oil, and other commodities.
• Make trading decisions: Monitoring USD Index movements helps investors plan positions and manage risks more effectively.

How to Calculate the USD Index

DXY Formula:

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

When the US dollar is the quote currency (indicating how many USD are needed to buy one unit of another currency), the exponent is negative. When USD is the base currency (indicating how many units of other currencies are needed to buy 1 USD), the exponent is positive.

However, traders do not need to perform manual calculations. On trading platforms, you can easily find the DXY or USDX index using the symbol DX.

How to Read the DXY Chart

Practical Example: If on 20/09/2022 the DXY closes at 105, and on 21/09/2022 it moves up to 108, this indicates that the USD has strengthened by 2.85% against the main basket of currencies in one day.

Conversely, if the index drops to 103, the USD has weakened by 0.97% against the basket. These fluctuations occur continuously in real-time, reflecting changes in investor sentiment and global economic conditions.

Historical Context of the USD Index

Before 1973, under the Bretton Woods agreement signed in 1944, the US dollar was pegged at a fixed rate of 35 USD per ounce of gold. After President Nixon abolished the gold standard and allowed the US dollar to float freely on the foreign exchange market, the Federal Reserve (FED) established this index in 1973 to monitor the actual value of the US dollar on the international stage.

Related Concepts of the USD Index

Currency Basket: A collection of different currencies, each with its own weight. In the USD Index, EUR has the highest weight at nearly 58%.

Broad Index (Broad US Dollar Index): Created by the FED in 1998, this index includes currencies from 26 countries and regions with annually adjusted weights. It provides a more comprehensive view of the dollar’s strength compared to the USDX.

Note on Symbols: Do not confuse the USD Index (DXY, USDX) with the digital USDx, developed by Lighthouse based on blockchain technology. Although the symbols are similar, they are two entirely different assets.

Understanding the USD Index and how to utilize it in analysis will help Forex traders make more accurate and effective trading decisions.