The U.S. Dollar Index Chart: What It Means For Forex Trading

Posted by Nick Niesen on October 29th, 2010

The U. S. Dollar Index is an index for currency traders, and it consists of a geometric weighted average of a basket of foreign currencies against the United States Dollar. The U.S. Dollar Index, just like stock indexes, provides a general indication of the value of a basket of securities. In this case the basket holds securities that consist of other major world currencies.

The U.S. Dollar Index has a basket that consists of six foreign currencies. These are the Euro, the Yen, the Cable, the Loonie, the Kronas, and the Francs. The index is made up of six currencies, but it includes seventeen countries. This is because there are twelve members of the European Union, plus Japan, Great Britain, Canada, Sweden, and Switzerland. These seventeen countries may only be a small percentage of the countries in the world, but there are many other currencies that follow the U.S. Dollar Index closely. The index is a great tool for measuring the global strength of the United States Dollar.

The components of the U. S. Dollar Index have a geometric weighted average. This is to factor in the fact that not every country is the same size, so each country is given an appropriate weight when the U.S. Dollar Index is calculated. Euros account for a large portion of the U.S. Dollar Index, more than fifty percent. The other five countries in the basket make up a combined total of forty three percent of the basket, with euros consisting of the other fifty seven percent.

The Federal Reserve uses another kind of dollar index, and this is called the trade-weighted U.S. Dollar Index. This index was created by the Feds to more accurately reflect the value of the dollar against foreign currencies based on the competitiveness of U.S. goods compared to other countries. The biggest difference between these two indexes is the basket of currencies that are used as well as the relative weights of the currencies. The weights are based on annual trade data, and this is why it is called the trade weighted U.S. Dollar Index.

No matter which U.S. Dollar Index you are looking at, these indexes help Forex traders know the value of the United States Dollar, and the global strength as well. Forex traders use these indexes to help them determine the value of a currency when compared to the U.S. Dollar. There are two U.S. Dollar Indexes, and the second one is called trade weighted U.S. Dollar Index. This index is based more on actual trade data, but countries are given weights in this index as well.

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