The US dollar index, which comprises a basket of currencies through which the US dollar's value is compared against, is also referred to most traders by USDX. This basket of currencies has the EUR, GBP, JPY, CAD, SEK, and CHF. Also, note that the euro zone has 17 member nations, which means that the dollar index is made up of a total of 22 countries. These then make the up the weights assigned to the different currencies when the geometric average of the basket's value is computed.
Just as normal currencies being traded in the forex market have line or candlestick charts, the value of the dollar index is also monitored through the same kinds of charts. In addition, the movement of the index is tracked in terms of points and not in pips. The dollar index was established in March 1973, as countries agreed to compare the value of their currencies against the dollar at the start of the base period.
A more complex kind of USDX, known as the trade-weighted index, is also being watched by the US Federal Reserve. This particular index makes use of different weights per currency component based on their contribution to global trade activity. This comprises a larger number of currencies from different countries, such as Taiwan, Israel, Singapore, Malaysia, and other developing nations. The Fed, or the US central bank, uses this index to keep track of the competitiveness of US products in the global market.
When it comes to forex trading, the dollar index is often monitored so that traders can figure out if the US dollar is about to reach a bottom or a top. For instance, EUR/USD can be selling off aggressively and traders could predict an end to the selloff by watching resistance levels on the dollar index. In another example, USD/JPY can be moving inside a range and traders can anticipate a breakout if USDX shows signs of breaking out in either direction.
In a nutshell, using USDX in online currency trading means that you have to remember these things: If the dollar is the quote currency, this means that the currency pair will move in opposite direction to the US dollar index just like EUR/USD's example. If the US dollar is the base currency, this means that the currency pair will move in the same direction to the index just like the USD/JPY example.
