Let’s jump right into it. It’s called the “Dixie.”
The US Dollar Index (aka DX, USDX, DXY) is used to measure the value of the dollar. This is done by pitting the USD against a basket of six world currencies – the euro, Canadian dollar, Japanese yen, Swiss franc, British pound sterling, and Swedish krona.
When taking the currency pairs to calculate the index, the US dollar becomes the “quote currency” for the euro and pound, while being used as the “base currency” for the rest. What this means is that the price of one euro will be quoted in dollars, e.g. €1 might be worth $1.13. When the USD is the base currency, it tells us, for instance, how many Japanese yen we can buy for $1. So, $1 might be worth ¥110.
- The DXY is currently calculated by factoring in the exchange rates of the above six currencies.
- The value of the Dixie is a fair indication of the dollar’s value in the global markets.
- The index is designed, published and maintained by the ICE (Intercontinental Exchange, Inc.)
How to Read the Chart
When studying the chart you’ll see that the index goes up when the USD gains strength, compared to the other currencies.
The DXY was given a base value of 100.000, when it was established in 1973. What does this mean?
- If the index hits a value of 90.000, it represents a -10% drop in the value of the dollar relative to the basket of currencies, i.e., (90.000 – 100.000).
- Alternatively, a +10% rise (110.000 – 100.000) represents a value of 110.000 on the chart.
Recall that moving strip you see running through the bottom of the TV screen when you watch Bloomberg or CNN Money? It is live feed for Dow Futures provided by the ICE. This is where the significance of DXY comes in, and it’s updated whenever the US dollar markets are open, or from 5:00pm EST on Sunday (since it is Monday morning in Asia and Australia) to 5:00pm EST on Friday. And when it’s open, it stays in operation 24 hours a day. So the index chart is calculated 24 hours a day, 5 days a week.
A Quick Backstory
To talk about the beginnings of the dollar index, we need to talk about ex-President Nixon. The dollar price was fixed at $35 per ounce of gold before the creation of the index, and it had been that way since the 1944 Bretton Woods Agreement.
But a tectonic shift occurred in 1971, when President Nixon abandoned the gold standard, which in turn allowed the value of the dollar to float freely against other currencies of the world. This is when tracking the dollar’s value relative to certain foreign currencies started, which led the Federal Reserve to create an official index in 1973 to keep track of the dollar’s value. So, in reaction to the ongoing shifts in forex rates, the dollar index chart changes constantly.
Guess what’s a registered trademark now? The term “US Dollar Index.”
Speaking of the index value, though at the start, the base value was set at 100.00, it has since traded as high as 164 in 1985, and as low as 70 in 2008 (yes, the same recession you see in The Big Short. Not watched it yet? Netflix, tonight.)
The Dollar Index Formula
DXY = 50.14348112 × EURUSD-0.576 × USDJPY0.136 × GBPUSD-0.119 × USDCAD0.091 × USDSEK0.042 × USDCHF0.036
The value of each currency is multiplied by its weight to get the value of the US dollar index, which is a positive number when the USD is the base currency, and negative when it is the quote currency. Confused? Don’t worry, these days technology does all the calculating for us. All we need to do is read the chart.
- The elimination of the gold standard gave birth to the US Dollar Index.
- Economic conditions within the United States and other countries can affect the dollar’s index value.
- The Dixie value reached its lowest point in 2008 and its highest in 1985.
Significance of the Index
The supply and demand of the US dollar affect the DXY, as well as the currencies that are pegged to the greenback. These factors influence the price of each currency pair in that formula we talked about earlier.
On the other hand, the supply and demand for these currencies are heavily influenced by the monetary policies (particularly the interest rates) set by the central bank of each country. Other major factors that impact dollar value and therefore the DXY chart are inflation, the nation’s economic performance, credit ratings, market sentiment and of course, geopolitical developments.
Trading the DXY
The US Dollar Index can be traded using futures and options or, where permitted, spread betting. CFD trading is also a convenient way to speculate on the future performance of the index. Basically, it is an index and can therefore be traded similar to equity indices, like the Dow Jones or S&P 500. Also, the index is available indirectly as part of exchange traded funds (ETFs).
Traders can monitor the value of the USD by referring to the Dixie, comparing it to a bunch of select currencies. It offers an effective way to keep an eye on several USD pairs at one time, rather than monitoring each pair separately. It offers good information for deploying effective risk management measures too.
However, before you start using the index, either for forex trading or index trading, learn the ropes of technical analysis. This will allow you to use proven trading strategies, such as trend trading or swing trading.
Was that too much jargon? Don’t worry, we’ve got your back. Simply register with the 360 Capital Academy and familiarise yourself with the financial market of your choice. Got a question for our team? Tweet us @360CapitalLtd and we might include it in our future articles and education centre.