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Role of the United States Dollar Index in Forex Trading

Role of the United States dollar index in forex trading

A Brief introduction to the United States dollar index: The United States dollar index is simply an index or measure of the value of the US dollar relative to a basket of foreign currencies, and these currencies hold different wings. It reflects the dollar performance against the basket of currencies. After the abolition of gold standards in the foreign exchange markets dollar floats freely in the market for value evaluation of goods. The base value of the greenback index began at 100, and it tracks the contrasting six foreign currencies for their exchange rates.

Most of the dollar index has the EURO or the EURO US dollar pair in it. When the United States dollar and euro currency pairs are taken in contrast, the index will show the rise and drop respectively for these two. Once you have got a bias on the US dollar, the next step is to look at the majors and spot the best idea based on the preference from your United States dollar index analysis.

Interpreting the United States Dollar Currency Index corresponding to the foreign currency 

The value of the United States Dollar Index can provide an investor or professionals thought of how much the United States greenbacks has an increase or dropped corresponding to the initial point of the index back in the year 1973

For instance, if the index presently has a value of about 96.65, then it reflects that the dollar has dropped by approximately 3.35 per cent as compared to the bunch of sec currencies since 1973. Similarly, if the United States dollar index is trading at the value of 115, then it would indicate the United States greenbacks has increased by approximately 15 per cent corresponding to the USDX bunch since the commencement of the index.

Component Currencies within the U.S. dollar Index

The value of the United States dollar index is estimated by using the geometric mean of the rate of exchange of the United States dollar against a basket consisting of foreign currencies. Every component of these currencies applies to a chosen group of 6 significant trading partners of the U.S, which are utilized to estimate the United States dollar index with different weightings. The table given below lists the basket of the top six elements currencies which presently helps in making up the United States dollar index and their corresponding percentage weighting: 

Country or Bloc Currency code Currency Weight per cent
European Union EUR EUR 57%
Japan JPY Japanese Yen 13.6%
United Kingdom GBP Pound Sterling 11.9%
Canada CAD Canadian Dollar 9.1%
Sweden SEK Swedish Krona 4.2%
Switzerland CHF Swiss franc 3.6%

table 1: A table listing the six present components of the United States Dollar Index and their corresponding weightings.

Many economists and investors assume that the United States dollar index basket must be updated to indicate the fact that the U.S is presently making more trade with countries like Mexico, South Korea, Brazil, China. On the other hand, they are making less trade with countries, including Sweden and Switzerland. 

The Fed’s Trade Weighted U.S dollar index 

Another important U.S solar index is the Trade Weighted U.S dollar index or in short, TWDI which has been estimated, printed and seen by the U.S Federal Reserve Bank since 1998. This index brings a much wider assessment of the United States dollar’s value compared with a bunch of 26 currencies. It permits the Fed’s monetary policymakers to judge how competitive the United States products are compared to products manufactured by other nations.

Element currencies within the Fed’s Trade Weighted dollar index

The table provides below list the bunch of 26 element currencies which currency build up the Fed’s comprehensive index of the foreign currency exchange value of the greenback, in addition to their individual weightings: 

Euro areas 16.638
Canada  12.664
Japan 6.462
Mexico 12.119
China 21.562
United Kingdom 3.322
Taiwan 2.387
Korea 3.929
Singapore 1.665
Hong Kong 1.328
Malesia 1.536
Brazil 2.052
Switzerland 1.804
Thailand 1.381
Philippines 0.572
Australia 1.23
Indonesia 1.007
India  1.991
Israel 1.01
Saudi Arabia 0.957
Russia 1.37
Sweden 0.66
Argentina 0.55
Venezuela 0.33
Chile 0.793
Colombia 0.69
Total 100

Table 4: A table listing the twenty-six present countries which currencies are components of or trade-weighted United States dollar index or the Fed’s wide-based TWDI and their corresponding weightings in 2016.

Glance over forex trading

It is also known as the foreign exchange market in the global marketplace where the traders of different countries trade with each other with their respective currencies. We can see that the world is now an interconnected market of different industries like commerce, trade, tourism etc. The Forex market is a tremendous and huge liquid asset market in the world. It exists in cash as well as in derivatives forms which offers you a variety of future options and swapping of currencies over a wide range. 

What is the forex market?

It is a place where different currencies are traded. Currency is a crucial asset for buying and selling goods in any country. Similarly trading worldwide in a global marketplace, local currencies can be traded with the current exchange rate in the foreign market. One novel aspect of the forex market is that there is no specific central place of exchanging currencies. Rather it is exchanged by electronic medium over the counter (OTC), which is a digital medium of exchange where transactions take place with the help of computer networking where traders are connected. So, it is a clean, faster and secure means of trading which also provides 24 hours in a day and five days in a week opening of markets across the world.

It is the largest platform for the traders in contrast with different trading volume across the globe, which assist the traders in getting an entry and exiting a position in any of the currency’s options in a blink. It also provides a lesser risk-taking path for those traders having limited funds by means of day trading, also known as swing trading. It also offers a long-term plan for those who want to invest a huge amount.

Features of the forex market 

1) The markets open for 24 hours a day, except for the weekends, unlike commodities or equity markets that open only for a few hours. 

2) Volume of the transaction is extremely high in the foreign exchange market. Thus, these markets are more liquid compared to any other market.

3) Foreign exchange markets are available in almost every country, and hence from the geographical point of view they are everywhere in the world, this makes them unique. 

4) Foreign exchange markets are the toughest markets to trade in because the currency exchange rates are affected by several factors such as geopolitical factor, liquidity and interest rate. 

5) Foreign exchange market is for the big players because generally, it is the government and big banks trade in these marketplaces.

Can the US dollar index help traders in forex trading?

In forex trading, we know that many currency pairs are standing in tough trading contrast, and it is hard to select one among them. Either you must invest emotionally and may get the profit out of it. Still, as per the trend of trading in the last few months, there are lesser reliable reasons for trading because of choppy price action, low volatility, momentum appearing and disappearing, and these hurdles can’t make a task easier for a trader. So, dollar indexes clear the scenario over market trends. It acts as an indicator by which we can take a close look and technical investigations over the latest market moments and pricing.

Applying United States dollar index movements to forex trading

Investors can use the observed movements in a United States currency index (like the USDX) to provide them with an idea of how the United States dollar is varying in value compared to the element currencies in the index. For instance, if the dollar index is surging then so likely is the United States dollar. On the other hand, if the United States dollar index drops, then the dollar is likely to fall in value in the foreign exchange market. 

Many financial media breaks report on fluctuation in the United States dollar index to provide their customers with an idea on how the United States dollar performed in the currency exchange market as an option to note how particular currencies surges or dropped versus the greenback. 

The United States dollar index can also be utilised as an inverse signal of the strength or power of the European Union’s consolidated Euro currency. It is because this currency (EUR) is estimated at an impressive 57.6 per cent in the index. The next big currency in this list of weighting indexes is the Japanese Yen at just 13.6 per cent. 

Another important thing for foreign exchange investors to learn is how market movements in the United States dollar index relate to the fluctuation in the element currencies quoted against the United States dollar. For instance, if an element currency pair is marked like USD/JPY, with the USD on the left end of the slash and the foreign currency at the right side of the slash, then the dollar index and the currency pair must be positively correlated. With this, they both should surge at the same time and drop at the same time.

In contradiction, when an element currency pair is marked as EUR/USD, with the foreign currency placed on the left side of the slash and the United States dollar at the right side of the slash, then the currency pair and the dollar index are inversely proportional. It means that they must move in the two opposite directions, with one falling and the other rising in the value.

How can one start forex trading? 

For entering the foreign exchange market, a trader needs to open an account with the trusted brokerage firm. ETFinance is the one which can serve the purpose. 

ETFinance is a leading firm providing different trading opportunities. The various markets provided by the broker includes indices, stocks, forex, commodities and cryptocurrency. Account opening with ETFinance requires just three simple steps. 

1) Enter the essential details like name, surname and mobile number for verification and registration process.

2) Upload all the income-related documents on the broker website. 

3) Choose the trade you want to pursue, deposit the requisite amount and start trading

Trading charges and features of ETFinance: 

  • 1) Regulated by CySEC
  • 2) Foundation Year:2018
  • 3) Demo: Available for traders 
  • 4) Max Leverage: 1:500
  • 5) Min Deposit: $250
  • 6) Withdrawal Options: Credit Card, Wire Transfer 
  • 7) Deposit Options: Credit Card, Wire Transfer
  • 8) Tradable Assets: cryptocurrencies, commodities, stocks, currency pairs, futures
  • 9) Publicly Traded: No
  • 10) Commission on Trades: No
  • 11) Trading Platforms: MetaTrader 4
  • 12) Fixed spreads: No
  • 13) Operating System Compatibility: Desktop platform (Mac), Desktop platform (Windows), Web platform
  • 14) Mobile trading: iOS, Android
  • 15) Accepts United States Clients: No

Summary 

Currency investors observing the rate of exchange or price movements in the different pairs of currency often analyse the United States dollar. They generally ask whether the price variation is because of revaluation of the foreign currency or it is due to a general shift in the price of the dollar. Hence, here comes the role of the dollar index. It is the reason why one should be aware of these kinds of terms and their mechanism in the financial market. 

The bottom line

The importance and use of the dollar index must be clear now. This guide has covered all the essential information a trader requires, but in case you want to explore the other related terms, trading style and forex trading, you can visit website fxreviews.best. Apart from forex related topics, there are other blogs containing information on cryptocurrency, indices, stock, future and options with their strategies, features and drawbacks.

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