12.What is the Dollar Index in forex?
The Dollar Index measures the value of USD to see if the dollar is stronger or weaker against six other currencies. Acronyms of the Dollar Index in the financial market include:
All trading codes in Futures.
USDX now includes Euro (EUR), Japanese Yen (JPY), British Pound (GBP), Canadian Dollar (CAD), Swedish Krona (SEK), and Swiss Franc (CHF). However, since Euro had not been launched when USDX was introduced, the index had a currency basket of ten currencies including Deutsche Mark, Italian Lira, French Franc, Dutch Guilder and Belgian Franc in the earlier years.
What is The history of USDX?
After World War II, USD was facing an overwhelming depreciation due to imbalanced trade. The USD crisis occurred as many as four times and the Bretton Woods system collapsed, which made major western economies abandon fixed rates with the USD and adopt floating exchange rates. When USDX was introduced in March 1973, the dollar index was 100. Providing a good reference of USD against currencies of countries that have close trading relations with the US, the index also reflects the changes of export competitiveness and import costs of US.
How is USDX calculated?
The USDX is calculated by factoring in the average value of six currencies:
EUR with the highest ratio of 57.6%; JPY of 13.6%; GBP of 11.9%; CAD of 9.1%; SEK of 4.2% and CHF of 3.6%.
The formula is as follows:
DXY = 50.14348112 (fixed) × EURUSD -0.576 × USDJPY 0.136 × GBPUSD -0.119 × USDCAD 0.091 × USDSEK 0.042 × USDCHF 0.036
The merits and drawbacks of USDX
The structure of the USDX currency basket has not been adjusted for many years, therefore EUR still holds the highest ratio of nearly 60% – which means the appreciation and depreciation of EUR poses substantial influence towards USDX, and it might cause the fluctuation of USDX disproportionately. This means that USDX might not be able to reflect the actual fluctuations of USD against other currencies.
Related Article: What are the major currencies?
USDX is criticized for failing to include currencies that are more familiar among members of the public. This includes:
- Chinese Yuan (CNY)
- Australian Dollar (AUD)
- Indian Rupee (INR)
- Singapore Dollar (SGD)
Investors can’t gauge the whole picture of the USD value against other major currencies and be misled by index swings.
In conclusion, the international forex market and financial news still cite USDX to reflect the overall USD rate. Due to the appreciation or depreciation of USD, USDX is still able to reflect the uptrend or downtrend of USD against other currencies, even though the index doesn’t include some popular currencies in the market in its basket.
In the futures market, individual investors, businesses, and manufacturers can trade the Dollar index to hedge the risks of the forex market, regardless of whether they actually hold USD or not.
Next Article: 13. What is reserve currency?
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