US Dollar Index
The US Dollar Index is an important financial index that plays a role in the Forex market. Here are the basics of how it impacts you as a Forex trader.
The Basic Premise
The basic idea behind the US Dollar Index is that it is a comparison of the United States dollar and several other currencies. The currencies are combined into a basket and compared to the value of the dollar. This essentially tells you how strong the dollar is in relation to the other major currencies of the world.
The Basket of Currencies
When you look at the index, you are looking at a comparison of the dollar to a basket of six currencies. The currencies included in this basket are the Euro, the Yen, the Pound, the Krona and the Swiss Franc.
When the dollar is compared to these currencies, it is not on a one-to-one basis. Instead, each currency is weighted in the basket to reflect the strength of the currency. For example, the Euro make up the largest part of the basket because it is used in 16 different countries in the European Union.
The Euro makes up a little over 58% while the Japanese Yen is the next biggest currency with about 13.6% of the basket. After that you'll find the Great Britain Pound with about 11.9% while the Canadian dollar has about 9.1%. The Swedish Krona has about 4% while the Swiss Franc holds 3.6% of the basket.
Using it as a Trader
In the various foreign currency exchange locations of the world, they all pay attention to the index. This is because it can provide you with vital information when trading in the market. Most of the major currency pairs that are traded involve the United States dollar in some capacity. For example, the GBP/USD and EUR/USD pairs are two commonly traded pairs, both using the USD.
When you want to utilize this index in your trading, you can use it to gauge the relative strength of the dollar. For example, when the US dollar increases in strength in the index, it tells you what the dollar will do with most currency pairs.
If the index increases, it tells you that the EUR/USD and GBP/USD pairs are going to decline in value. This means that you would want to place a "sell" trade in your Forex trading platform.
While it is not the "be all, end all" indicator, it is another tool to put in your arsenal.
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