The US dollar is the most widely traded currency on the forex market. Over 80% of currency pairs traded feature the USD as either the base or quote currency. The performance of most major currencies are tracked by indices.
DXY definition
The DXY, or the US dollar index, is an index that tracks the performance of the greenback against other currencies, such as the Japanese yen, Swiss franc, Swedish krona, British pound, Canadian dollar, and an euro. The index was introduced after the Bretton Woods Agreement, which meant the dollar was no longer backed by gold.
DXY is the most commonly followed currency index on the forex market.
Why it is important for traders to understand the DXY
- The DXY measures the standing of the USD in global markets
- The euro makes up more than 50% of the dollar index. Understanding DXY in trading can help investors better trade EUR/USD pair.
- The dollar index factors in the exchange rates of EUR, CHF, CAD, JPY, GBP, and SEK
- The dollar index can be traded using options and futures contracts and funds tracking the index
DXY explained in more detail
After the gold standard was abandoned, countries switched to floating currency rates. The importance of the US dollar in global trade created the demand for an index that tracked the performance of the dollar against other important currencies.
The DXY consists of 6 currencies that are weighted as follows:
- EUR – 57.6%
- JPY – 13.6%
- GBP – 11.9%
- CAD – 9.1%
- SEK – 4.2%
- CHF – 3.6%
The dollar index is often used as the benchmark performance indicator for the US economy, alongside the S&P 500.
When the index is increasing, the other six currencies are losing ground. This can be due to changing inflation figures, trade, as well as a multitude of political factors.
Trading the dollar index is available through the stock market as well – using the ETFs that track the index, such as the Invesco DB US Dollar Index Bullish Fund (UUP) and the opposite bearish fund (UDN).
DXY Example in trading
The dollar index can be traded just like an equity index and is especially convenient for traders that cannot monitor the individual pairs that make up the index.
The index is often used as a reference point by traders holding pairs featuring the USD as the base currency. If the index is losing ground, a bearish trade on the USD/CAD pair for instance, might need to be reexamined.
The equity funds tracking the dollar index are ETFs, which means they can be traded on the stock exchange just like any other stock.
Buying 100 shares of UUP means the trader expects the dollar to outperform the six constituent currencies.
FAQs on the DXY
What does DXY measure?
The DXY measures the strength of the US dollar against six other major currencies, such as the EUR, SEK, CHF, JPY, GBP, and CAD. The dollar index is the benchmark index for the performance of the world reserve currency.
Can I trade DXY?
DXY can be traded using ETFs that track the index. Invesco’s bullish and bearish ETFs – UUP and UDN are two of such funds tradable on the stock market.