The strength of the USD: How to read the DXY index in forex trading

What is the USD Index and Why Is It Important in Forex?

The (USD Index, abbreviated as USDX or DXY), is a tool for measuring the relative value of the US dollar against a basket of major world currencies. Designed and maintained by ICE (Intercontinental Exchange, Inc.), this index reflects the purchasing power of the dollar when compared to the United States’ major trading partners.

If the USD Index rises, it means the US dollar is appreciating against other currencies in the basket. Conversely, when the index falls, the US dollar is weakening. This is crucial information that professional traders need to monitor to forecast trends in the foreign exchange market.

Structure of the Currency Basket in the USDX

The USD Index is calculated based on a basket of six major currencies, with different weights depending on trade importance:

• EUR (Euro): 57.6% - the largest share
• 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%

This structure is designed to reflect countries with strong trade relations with the US. The Euro dominates with nearly 58% weight, which makes sense since the Eurozone is one of the US’s largest trading partners.

History of the USD Index

The USD Index was first introduced in 1973 with a base level set at 100 points. This number serves as a reference point—subsequent values are compared to this baseline.

Historical fluctuations:

• Highest peak: 164.72 points in February 1985
• Lowest point: 70.698 points in March 2008

These significant fluctuations reflect major economic changes and monetary policies worldwide. Notably, the low in 2008 occurred during the global financial crisis.

The Relationship Between the USD Index and Major Currency Pairs

USD Index and EUR/USD pair

The relationship between USDX and the EUR/USD pair is inverse—when one rises, the other tends to fall. The reason is simple: EUR accounts for 57.6% of the USD Index basket.

When the US dollar strengthens (USD Index increases), traders often sell EUR and buy USD, causing the EUR/USD rate to decrease. This creates a strong negative correlation between these two indicators.

USD Index and USD/JPY pair

In contrast to EUR/USD, the USD/JPY pair has a positive correlation with USDX. When the dollar strengthens (USD Index increases), the USD/JPY pair also rises. This is because in this pair, USD is being bought with Japanese Yen, and when USD is stronger, the price of this pair naturally increases.

USD Index and Gold Price

The correlation between the USD Index and gold price is inverse and very clear. Gold is priced in US dollars on the international market. When the US dollar weakens (USD Index decreases), foreign investors can buy gold at lower costs, leading to an increase in gold prices. Conversely, when the dollar strengthens (USD Index increases), gold prices tend to fall.

How to Calculate the USD Index

This index is calculated using a specific mathematical formula:

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 use negative exponents (because they are quote currencies - how many USD can be bought with one unit of EUR/GBP)
• JPY, CAD, SEK, CHF use positive exponents (because they are base currencies - how many units of these currencies can be bought with one USD)

However, you don’t need to perform manual calculations. On most Forex trading platforms, you can find the USD Index using symbols like DX, DXY, or USDX.

How to Read and Interpret the USD Index

To better understand how to read this index, consider an example:

If on 20/9 the USD Index closes at 105, and on 21/9 it moves up to 108:

• The US dollar has appreciated by 2.85% against the basket of major currencies
• Indicating a strong upward trend for the dollar

If the index drops to 103:

• The US dollar’s value has decreased by 0.97%
• This signals a weakening of the dollar in the international market

These changes occur in real-time, reflecting immediate market movements.

Why Do Traders Need to Follow the USD Index?

1. Forecast Currency Trends

The USD Index provides a comprehensive picture of the US dollar’s strength. By monitoring this index, traders can forecast the trend of major currency pairs. When USDX rises, pairs like EUR/USD, GBP/USD tend to decline.

2. Analyze Commodity Markets

Gold, silver, oil, and other commodities are all priced in dollars. Therefore, the USDX is an important indicator for predicting movements in commodity markets. When the dollar weakens, commodities usually increase in price (measured in dollars).

3. Identify Trading Opportunities

By tracking the USD Index along with other technical indicators, traders can identify potential trading opportunities on Forex pairs such as EUR/USD, USD/JPY, GBP/USD, AUD/USD.

Differentiating the USD Index from Other Related Indices

( Broad Index )The broad index###

In 1998, the Federal Reserve (FED) developed an expanded version called the “Trade-Weighted US Dollar Index.” This index includes currencies from 26 countries and regions, with annual weight adjustments based on current trade data. It offers a more comprehensive view of the US dollar’s value compared to the traditional USDX.

( USDX Cryptocurrency

Do not confuse the USD Index )DXY### with USDX—a cryptocurrency developed by Lighthouse based on Blockchain technology. Despite the similar name, they are entirely different concepts.

The Historical Context of the USD Index

The creation of the USD Index is directly linked to a historic turning point in the international monetary system. Before 1973, the US dollar was pegged to gold—specifically (at a rate of one ounce of gold )per the Bretton Woods Agreement of 1944$35 .

When President Nixon ended the gold standard and allowed the dollar to float freely in the foreign exchange market, the Federal Reserve needed a tool to monitor the dollar’s value. The USD Index was introduced in 1973 and has since become the standard measure of America’s monetary strength.

Conclusion

The USD Index is an indispensable analytical tool for any forex trader. By understanding how this index works, its relationship with other currency pairs and commodities, you can make more informed trading decisions. Monitoring the USD Index on real-time price charts will help you catch market signals early and develop more effective trading strategies.