The US dollar index (USDX) is an important analytical tool
for traders in just about any market. The USDX is actually a futures contract
which means that if you have a futures trading account you could trade this
instrument like corn, oil, gold or currency futures contracts. However rather
than trading the USDX most retail traders use it as way to analyze the relative
strength or weakness of the US Dollar in general.
The USDX compares the US dollar (USD) against a basket of
other world currencies. This basket represents most of the largest free
floating, major currencies in the world on a weighted average basis. The
currencies included are the euro, yen, British pound, Canadian dollar, Swedish
krona and Swiss franc. Each of these currencies are given a weight within the
index with the largest weight given to the euro.
The euro is typically half the total weight included in the
average the chart for the USDX and will often look like a chart of the USD/EUR
futures contract. Spot forex traders will notice that the USDX is very similar
to an inverse of the EUR/USD spot forex pair. However, because the USDX
includes 6 different currencies it is a better measure of USD strength than any
single currency pair including the EUR/USD.
The USDX was established in 1973 with a starting value of
100. That means that if the USDX is measuring less than 100 the USD has lost
relative value compared to what it was worth in 1973 and if it is above 100
then the USD is stronger than it was in 1973. Currently the USDX is hovering around
82, which means that it is 18% weaker than its starting value. The dollar has
not always been weaker than it was in 1973, the USDX showed a 20% improvement
in value in the USD in 2001 and 2002.
The USDX is particularly useful for traders in the bond,
currency and gold markets. For example, a strong USD is usually correlated with
falling gold prices, which means that gold traders are very interested in a
break out on the USDX even though they may not be trading the USD directly.
Similarly, global crises often increase demand for the USD as investors seek a
shelter from uncertainty. This will drive the value of the USD up and often
bond yields will drop. These are just two examples of how the USDX is one more
inter-market tool you can use for evaluating capital flows and finding new
trading opportunities.
Charts for the USDX on the pairs analysis pages in the forex
section of the Learning Markets website but if you are interested in trading
the USDX you have two attractive alternatives. First, you can open a futures
account. There are futures and options on futures available on the USDX that
trade on the New York Board of Trade.
Second you can trade ETFs that track the USDX itself.
PowerShares offers two ETF alternatives for trading the index. The first is UUP
which invests in long futures contracts on the USDX, which means it will move
the same direction as the dollar index. The second is UDN which invests in
short futures contracts on the USDX, which means that it will rise in value
when the dollar index weakens. If you are bullish the dollar you could buy UUP
and if you are bearish the dollar you could buy UDN.
Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC.
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