The Importance of the US Dollar Index

According to the 2019 Triennial Survey of turnover in OTC Forex markets, the US dollar retained its dominant currency status, on one side of 88% of all trades. Additionally, more than 60% of foreign exchange reserves are denominated in dollars, according to the International Monetary Fund.

Traditional major currency pairs also include the US dollar. On top of this, the greenback is the standard currency in the commodity market and therefore directly impacts commodity prices.

What Is the US Dollar Index?

The majority of traders understand how support and resistance levels are applied on charts and also know how to read technical indicators, such as the relative strength index. Another tool that deserves mention, however, is the US dollar index.

Developed in March 1973 by the United States Federal Reserve, the US dollar index, or more commonly referred to as the ‘DXY’ (ticker symbol used by Bloomberg’s Terminal) or ‘USDX’, is a measure of the value of the US dollar against a basket of six major currencies.

In terms of weighting, the euro (EUR) controls the largest percentage share at approximately 57.6%. This is followed by the Japanese yen (JPY) at 13.7%, the British pound (GBP) at 11.9%, the Canadian dollar (CAD) at 9.1%, the Swedish Krona (SEK) at 4.2% and the Swiss franc (CHF) at 3.6%.

Using the DXY

Currency pairs with the US dollar representing the base currency (the first currency in a pair’s quotation – USD/CHF, for example) may be an attractive buy if the DXY is oversold. Similarly, selling these markets is appealing if the DXY is overbought.

If, on the other hand, the USD represents the quote currency (the second currency in a pair’s quotation –EUR/USD or GBP/USD), buying these currency pairs may be appealing if the DXY registers overbought conditions. And, similarly, traders may consider selling these markets if the DXY puts forward an oversold reading.

Other Tools

You can use any tool you feel offers the clearest perspective in terms of overbought and oversold conditions on the DXY. It does not have to be supply and demand or trend lines.

Knowing where the DXY is positioned is important. It adds weight to trade setups.

Feel free to experiment with different technical tools. You might find technical indicators are more suited to identify DXY overbought/oversold conditions, rather than price action.