DXY — US Dollar Index in Forex

In forex trading currencies are traded in pairs. It indicates the worth of 1 currency against the worth of another currency. within the case of the US dollar index, the worth of the US dollar is indicated in reference to the worth of a basket of currencies. this text discusses the history of the US Dollar Index (DXY), the way within which the index and its derivatives are calculated also because the implications, and eventually, how it’s useful to the forex trader.

Historical Background

Until the primary 1/2 1971, the international standard was governed by the Bretton Woods system, which is closely associated with the gold standard system that existed in 1940. Under this method the foremost currencies were pegged to the US dollar, which was successively linked to the gold reserves at Fort Knox. The inherent loopholes during this system and Europe’s move towards the free movement of capital resulted within the collapse of the system.

In August 1971, US President Richard Nixon unilaterally announced the discontinuation of the Bretton Woods system and therefore the abolition of direct international conversion from US dollars to gold. thanks to the decline in gold reserves within the country by nearly a 3rd. Especially after France demanded to convert the US dollars in its possession into gold, which prompted the Americans to float the dollar and liberalize the rate of exchange, which paved the way for other currencies to follow an analogous path.

The discontinuation of the Bretton Woods system led to the need of making a mechanism to see the worth of the US dollar against other major currencies. In 1973, the US Fed established what’s called the dollar index to live the performance of the US dollar against six other currencies: the euro, the japanese yen, country pound, the dollar, the Swedish monetary unit, and therefore the Swiss franc. At the time of the creation of the US dollar index, the currencies of the countries that controlled trade with the us were used and also the weighted rate of every of the currencies that conjure the index was as follows:

Euro (EUR) – 57.6%
Japanese Yen (JPY) – 13.6%
Pound sterling (GBP) – 11.9%
Canadian Dollar (CAD) – 9.1%
Swedish Krona (SEK) – 4.2%
Swiss franc (CHF) – 3.6%
Before the Euro came into existence on January 1, 1999st, the US Dollar Index was made from 10 currencies including the mark. And upon the emergence of the Eurozone, it resulted in an adjustment or rebalancing of the currencies that conjure the DXY dollar index. Since then no changes are made, although those currencies aren’t any longer the foremost traded with the US dollar.

The Mathematical Formula Behind The US Dollar Index

The formula for calculating the US dollar index is as follows:

DXY = 50.14348112 x EURUSD -0.576 x USDJPY 0.136 x GBPUSD -0.119 x USDCAD 0.091 x USDSEK 0.042 x USDCHF 0.036

If the US dollar is that the base currency within the pair, its weight coefficient is positive. On the opposite hand, if the US dollar is that the quote currency, then the coefficient of correlation of this pair is negative.

Interpretation

The value of the US dollar index enables the trader to grasp the extent of the dollar’s strength up and down against the basket of currencies and therefore the extent of this ups and downs. Similarly, if the US dollar index is trading at 75, it means the dollar has depreciated by 25% against a basket of currencies. Therefore, when the US dollar index is in an exceedingly clear uptrend, the forex trader should avoid short positions on the US dollar-based currency pairs and the other way around.

Trading The US Dollar Index

US dollar index futures are traded on the Intercontinental Exchange (ICE). The US dollar index is that the most generally recognized currency index. it’s worth noting that futures contracts were first introduced for trading on November 20, 1985. On September 3, 1986, US dollar index options became available for trading. Both futures and options are available exclusively for electronic trading on the ICE platform. The DX stands for futures contracts (SDX mini futures contracts) followed by the year and month code.

The price is updated once every 15 seconds using multiple data feeds from Forex. within the middle point the bid/ask quotation is employed to calculate the US dollar index and is passed on to varied data vendors. Some data vendors use their own code. as an example, Bloomberg uses the symbol DXY (commonly noted as Dixie). Trading within the contract begins at 18:00 EST on Sunday and ends at 17:00 EST on Monday. The market reopens at 8:00 ET and closes at 17:00 on Tuesday through Friday. just like other exchanges, traders can place trading orders during the pre-open period (30 minutes before trading / orders execution begins). Derivatives contracts also enable the investor to hedge his financial portfolio against the risks of the volatility of the US dollar. The ICE Dollar Index contract is that the only derivative instrument whose shares are traded on a regulated exchange, and provides a transparent price discovery mechanism. looking on personal ability, US dollar index derivatives are specifically traded by hedge funds and major realty investors with investment banks.

The US dollar index future contract size is $1,000 times the index value. for instance, if the US dollar index is trading at 96.550, the contract size is $96,550. the dimensions of the littlest price movement is 0.005 (a value of $5). The contracts have a quarterly expiration cycle – March, June, September and December. Daily settlement relies on the quantity weighted average price of all trades executed during the closing period (14:59-15:00 Eastern Standard Time). Although the dimensions of the tiniest price movement is 0.005, the settlement price is expressed as an extra 0.001. .

In general, US dollar index futures contracts are authorized to be offered by the Chicago Board of Trade (NYBOT), a subsidiary of ICE. DXY is additionally traded as ETFs, Exchange Traded Certificates and fund units through various exchanges.

Trade-Weighted US Dollar Index

In order to form the index relevant to the present economic situation, the Federal Reserve System established in 1998 an alternate to the US dollar index. First, there was a requirement for the index to incorporate the currencies of states like Brazil, China and Mexico, which are gaining importance in international trade with the USA. Secondly, the arrival of the euro made it imperative to own an alternate to the US dollar index. The newly created index is thought because the trade-weighted US dollar index or the broad range index.

Other Differences

With the currency composition and its corresponding weighting, we will easily understand that the US dollar index now not reflects the establishment. there’s ICE that charges an inexpensive amount reciprocally for its feed of instant and delayed offers.

Moreover, the weighted mean value utilized in calculating the US dollar index makes it costlier for market makers. Moreover, the chart of the US dollar index looks more or less like an inverted chart for the euro dollar. Finally, the difference in weight implies that the impact of the euro on the US dollar index is larger than that of other currencies, although this could not always be the case (for example, another round of monetary easing by the eu financial institution and therefore the Bank of Japan won’t create an analogous effect on the worth of the US dollar index).

Considering the above flaws, Dow-Jones Industrial Average and FXCM have created the DJ FXCM Dollar Index. This index consists of 4 major currencies – the euro, the yen, the Australian dollar, and therefore the British pound. All four currencies are given a 25% weight. this method enables the trader to perfectly track the trading position of 1 of the four currencies with relative ease by watching the DJ FXCM Dollar Index. The indicator may also be traded on the trading platform offered by the forex broker FXCM.

Conclusion

The US Dollar Index will be used as a fast reference guide to assess the strength of the US Dollar against competing currencies. However, given the massive investment required, it are often said that it’s only suitable for the highest traders. And you ought to check the indicator chart before entering a trade because it helps you to avoid false entries.