The US dollar stands in the list of strongest currencies, and we know it significantly participates in world trade. Even a slight fluctuation in the currency causes major downfalls, and so is the opposite case. But have you ever thought about how the US dollar is interpreted? How its value jumps up or down, or how it dominates world trade.
In this article, we will answer all the above questions and learn a bit about the dollar’s participation in trade.
The US Dollar Index has been introduced to interpret the strength of the US Dollar. The US dollar index is a standard index chart used to gauge the strength of the US dollar against a basket of currencies. It can be understood as a standard chart against which dollar value is calculated. Note that there is a handful of countries that the dollar is compared against.
All the above currencies have different proportions in the dollar index chart. While Euro carries the most weight ( 57%), Swiss Franc carries the least( 3.6%). When you see a Dollar index chart (aka DXY), it seems like a complex graph, having peaks of various intensities. These peaks represent the values of the dollar against other currencies. Let’s understand why the US Dollar index is needed.
What Is The Need Of The US Dollar Index?
The US Dollar Index is essential for traders to analyze market trends. Because world trade is dominated by the dollar, the need for a US dollar index is undeniable. Do you know the US dollar holds 59% of the global foreign exchange reserves, and it is also the world’s leading reserve currency? These factors ultimately make international trade analogous to the fluctuations in the value of the US dollar.
The primary purpose of DXY, for which it came into existence, is to check on the current US economy. A falling index indicates a weak economic condition, while an uprising chart shows a healthy US economy. DXY is vital for analyzing inflation, metal prices, and stock markets. So, the need for this standard chart is attributed to the importance of the US dollar. Additionally, investors and traders take refuge against risks by participating in the DXY.
How To Analyse The US Dollar Index?
Theoretically, when the graph goes up, it signifies a strong dollar, and if it goes down, that means the dollar is weak. However, when traders analyze the graph, there are specific mathematical calculations. First, know that DXY has a base value of 100.00. It means fluctuations are calculated out of 100. Let me clear the maths with a simple example.
Suppose the current value of the dollar is 80. We know the base value is 100. If the dollar is 80, it has depreciated by 20%. Because the standard figure is 100, any value of the dollar less than it would be considered depreciated; it is calculated as 100-80=20. Quite simple.
Similarly, if the dollar’s current value is 120, it is clear that there is a 20% hike from the base value. It means the dollar value has appreciated by 20%. It is calculated as 120-100=20.
The above calculations are simple. You can perform them just by looking at the chart, but if a deep understanding is what you seek, then a mathematical formula is there.
Formula To Calculate The US Dollar Index
This is for the geeky ones. The formula used to calculate the US Dollar index is given as
DXY = 50.14348112 × EUR/USD^(-0.576) × USD/JPY^(0.136) × GBP/USD^(-0.119) × USD/CAD^(0.091) × USD/SEK^(0.042) × USD/CHF^(0.036)
The above formula calculates the weighted average of the US dollar exchange rates, considering the exchange factor (~ 50. 1435).
Trading With The US Dollar Index
Trading with the US dollar index is one acceptable way for traders and investors to take the first step in the US economy and market. By trading in DXY, traders are exposed to the US economy and opportunities, and mainly, trading acts as a hedge against potential losses. Trading in DXY simply means investing in a market of multiple currencies. To trade in the US Dollar Index, follow the steps below-
- Open a trading account. A trading account is an entry gate in DXY trading. A reputed broker helps open a trading account.
- Make use of technical analysis. Entering into such a big market needs technical analysis. You must be able to locate entry-exit points, manage risk, and understand loss and profit to employ measures.
- CFD. DXY is widely traded as a Contract for difference (CFD). In CFD, a buyer pays to seller the difference in asset price in the current market and at the time of the contract. If the price at the time of the contract was $100 and the current market price is $250, the buyer will pay $150 to the seller.
Going Into The History Of The US Dollar Index
The US Dollar Index came into existence in 1973 after the collapse of Bretton Wood’s Agreement. Initially, the vision was to keep track of the dollar’s strength against other currencies. However, it was revised later to broaden its applications to analysis of the economy, market trends, etc.
Earlier, there were several European currencies in the index basket that were replaced by Euro in 1999. The highest dollar value was recorded at ‘165’ in 1984, and the lowest recorded was ‘70’ in 2007. Since then, the value has been between 80 to 110.
Conclusion
The US Dollar chart is of utmost importance in the trading world. People entering to step into international trade just can’t overlook the proper utilization of DXY. Additionally, the US dollar index allows traders and investors to sell or buy Dollar Index futures contracts. It is an acceptable way to enter the world trade market and extract its significant benefits. The modern world is looking more into this area, and an awareness of DXY trading would fuel future trading.
