You might be thinking, “Index in the forex market? Shouldn’t that be in the indices market?”
This market index is for the USD; the currency, not the stock markets of the United States. In its most basic, the Dollar index measures the value of the dollar compared to all currencies in the index basket.
With this reference, you can track the performance of major pairs and properly position your trade to the forex market.
In the previous lesson, you’ve learned how the Bretton Woods System made the US dollar what it is in the global economy today. However, understanding the evolution of the USD doesn't end there; now let’s get down to its continued significance post-Bretton Woods.
After the dissolution of the Bretton Woods system, the US Federal Reserve established the USDX (also known as the “Dollar Index”) to keep the currency to its premier market position as well as to track its value.
In its most basic form, the dollar index is the benchmark used to measure the value of the US dollar relative to a basket of foreign currencies.
The USDX (also known as the “Dollar Index”) is a measure of the US dollar value relative to a basket of foreign currencies. It consists of a geometric weighted average of USD against a basket of major currencies.
Note: The US Federal Reserve passed the responsibility of maintaining the USDX to the Intercontinental Exchange’s ICE Data Indices.
But what does this tell you?
Well, if the USDX market appreciates, the USD strengthens against the other currencies in the USDX. On the other hand, if the USDX depreciates, the other currencies in the USDX strengthen against the USD.
Hence, looking at the USDX price movement gives you strategic entry and exit points for your major trade.
Okay, we kept talking about the other currencies in the USDX. Now, let’s identify what currencies we are talking about here.
The dollar index consists of six foreign currencies. Here they are and their weighting in the USDX:
| Foreign Currencies | USDX Weighting |
| Euro (EUR) | 57.6% |
| Japanese Yen (JPY) | 13.6% |
| British Pound (GBP) | 11.9% |
| Canadian Dollar (CAD) | 9.1% |
| Swiss Franc (CHF) | 4.2% |
| Swedish Krona (SEK) | 3.6% |
But wait! What does USDX weighting mean?
Well, since not all six given countries are of the same size, ICE gave specific weighting to each America's principal trading partners. These weighted geometric averages for each currency in the index are based on how large the scope of the currency.
The Euro has the biggest weight since the currency is used by 19 countries. Followed by the JPY considering the strong economic status of Japan.
Meanwhile, the rest makes up less than 30% of the overall weight of the USDX.
Rememeber
To calculate the USDX price index, you simply look for the weighted average of the USD exchange rate against other USDX currencies. Here, you use the normalized indexing factor of ~50.1435.
Here’s the formula in calculating the USDX index price:
USDX = 50.14348112 × EURUSD^(-0.576) × USDJPY^(0.136) × GBPUSD^(-0.119) × USDCAD^(0.091) × USDSEK^(0.042) × USDCHF^(0.036).
Where;
- EURUSD represents the EUR (Euro) to USD exchange rate
- USDJPY represents the USD to JPY (Japanese yen) exchange rate
- GBPUSD represents the GBP (British pound) to USD exchange rate
- USDCAD represents the USD to CAD (Canadian dollar) exchange rate.
- USDSEK represents the USD to SEK (Swedish krona) exchange rate.
- USDCHF represents the USD to CHF (Swiss franc) exchange rate.
You’ve learned how the US dollar index can be a great tool for monitoring and predicting the potential movement of the major pairs. For the next lesson, you’ll explore another kind of USDX, the Trade Weighted Dollar Index.