What Is the US Dollar Index and How Can You Trade It? – Capital Sources

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The US Dollar Index (USDX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies. It was created in 1973 by the Intercontinental Exchange (ICE), formerly the New York Board of Trade (NYBOT) as a way to measure the value of the US dollar.

The index also includes the euro, the Japanese yen, the British pound sterling, the Canadian dollar, the Swedish krona, and the Swiss franc. In addition, on the ICE website, you can view real-time quotes for the USDX futures contract.

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What Is the Relationship Between the USDX and Other Dollar-Denominated Assets?

A higher US Dollar Index generally corresponds to a stronger US dollar. Moreover, it tends to be associated with lower prices for dollar-denominated assets such as commodities. Conversely, a lower USDX typically indicates a weaker dollar, often associated with higher prices for dollar-denominated assets.

How Do Traders Use the US Dollar Index?

The USDX can provide the forex trader with another tool in his belt to measure market moves. It does this by tracking the exchange rates of the other currencies in the index against the dollar.

As of May 2016, the euro made up roughly 57.6% of the USDX. Meanwhile, the yen, pound sterling, Canadian dollar, Swedish krona, and Swiss franc accounted for 13.6%, 11.9%, 9.1%, 4.2%, and 3.6% respectively.

The US Dollar Index Is Not a Benchmark

Some investors think of the USDX as a benchmark similar to the Dow Jones Industrial Average or the S&P 500. However, it is not. Instead, the USDX measures the value of the US dollar.

Can Investors Trade the USDX?

However, you can trade the USDX. The USDX is a traded futures contract on the ICE exchange. The contract is priced in US dollars per index point. For example, if the USDX trades at 90.00, and it costs $9,000 to buy one contract.

What Are Some Other Ways to Trade the US Dollar?

In addition to trading the USDX futures contract, there are several other ways to trade the US dollar, including:

• Currency ETFs such as the PowerShares DB US Dollar Index Bullish Fund (UUP) and the WisdomTree Bloomberg US Dollar Bullish Fund (USDU)
• Currency mutual funds such as the Rydex CurrencyShares Euro Trust (FXE) and the ProFunds UltraShort Yen (YCS)
• Forex pairs such as EUR/USD and USD/JPY
• Single currency futures contracts such as the Japanese Yen Futures (6J) and the Eurodollar Futures
• Single currency options such as EUR puts and calls or USD puts and calls

Which of these strategies is right for you will depend on your investment objectives, risk tolerance, and trading style.

How Does ICE Calculate the US Dollar Index?

ICE calculates the USDX by taking the geometric mean of the dollar’s value relative to its component currencies. In other words, it’s a weighted average of these exchange rates.

ICE performs the actual index calculation using the following formula:

USDX = 50.14348112 × EUR^0.576 × JPY ^ 0.136 × GBP ^ 0.119 × CAD ^ 0.091 × SEK ^ 0.042 × CHF ^ 0.036

In this calculation as elsewhere, EUR, JPY, GBP, CAD, SEK, and CHF represent the euro, Japanese yen, British pound sterling, Canadian dollar, Swedish krona, and Swiss franc, respectively. And ^0.576, ^0.136, ^0.119, ^0.091, ^0.042 and ^0.036 represent their weightings in the index calculation.

The calculation of the USDX is expressed as a base value that was set at 25 on March 16, 1973. This is the date when the USDX was first published.

So, how would an investor trade using dollar index if the USDX currently trades at 100? It has increased four-fold in value since its inception. Similarly, a reading of 50 would indicate that the U.S. dollar has lost half its value relative to the ICE’s basket of currencies since 1973.

Note These Key Takeaways

• The USDX is an index that tracks the value of the US dollar relative to a basket of foreign currencies.
• It is not a benchmark index but rather a measure of the value of the US dollar.
• ICE calculates the USDX by taking the geometric mean of the dollar’s value relative to its component currencies.

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Here’s What to Know If You Want to Use Trade the US Dollar Index

Now that we know what the USDX is and how ICE calculates it, let’s look at how to trade using dollar index in trading.

First, it’s important to note that the USDX is not a currency pair. Therefore, investors and traders cannot trade it directly on the foreign exchange market.

Instead, the USDX is traded as a futures contract on the ICE Futures US exchange. These contracts are traded in units of 1,000 index points (or $1,000) and have a minimum tick size of 0.0001 (or $0.01 per index point).

For example, if the USDX is trading at 93.50, that means one contract is worth $935,000 ((93.50 x 1,000) x $1). A move from 93.50 to 93.51 would be a tick up of one point and a move of $10 (93.51 – 93.50) x 1,000 x $1).

It’s also important to note that the USDX futures contract is a cash-settled contract, which means no physical delivery of currencies takes place. Instead, traders receive any profits or losses in US dollars based on the difference between the contract’s settlement price and its price at expiration.

Choose from Among Several Strategies for Trading the USDX

Like any other futures contract, traders can choose from several strategies to trade the USDX. Here are a few of the most popular ones:

• Long/short positions: A long position is one where you expect the value of the USDX to increase, while a short position is one where you expect it to decrease.
• Bullish/bearish positions: A bullish position is one where you expect the value of the USDX to increase, while a bearish position is one where you expect it to decrease.
• Momentum/contrarian positions: A momentum position is one where you expect the value of the USDX to continue moving in its current direction, while a contrarian position is one where you expect it to move in the opposite direction.
• Hedging: Hedging is a risk management strategy that involves taking offsetting positions in different assets to minimize your exposure to downside risk. For example, if you’re long USDX futures, you could hedge your position by being short EUR futures.

Regardless of your strategy, it’s important to remember that the USDX is a highly volatile market and that prices can move quickly. As such, it’s important to use stop-loss and limit orders to protect your positions.

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And Here’s a Quick Wrap Up

The USDX is an index that tracks the value of the U.S. dollar relative to a basket of foreign currencies. It is not a benchmark index but rather a measure of the value of the U.S. dollar. ICE calculates the USDX by taking the geometric mean of the dollar’s value relative to its component currencies. Finally, the USDX is traded as a futures contract on the ICE Futures U.S. exchange and is a cash-settled contract with no physical delivery of currencies.

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