Why a currency index is useful for a trader
Classic trading is speculative trading of a particular currency pair using fundamental analysis (news trading) and the use of a technical indicator. If we draw an analogy with the stock market, it is analogous to trading in securities. But there are also indices in the stock market, which are an aggregated indicator of it as a whole or of its individual segments. There is something similar in the foreign exchange market – the foreign exchange index.
What is Currency Index
A currency index is a value that shows the ratio of the price of a currency in relation not to a single other currency (as in a currency pair), but in relation to a basket of world currencies. The basket is formed from several freely convertible currencies, which have their share depending on the degree of participation of the country in foreign trade turnover.
The method of calculating the currency index is constant, but it can be revised and changed (USDX has changed 2 times in the entire history of its existence). The calculation principle is geometric weighted from a basket of several currencies. For example for:
- USDX (dollar index): EUR 57.6%, JPY 13.6%, GBP 11.9%, CAD 9.1%, SEK 4.2%, CHF 3.6%.
- EURX (Euro Index): USD – 31.55%, GBP – 30.56%, JPY – 18.91%, CHF – 11.13%, SEK – 7.85.
In the stock market, traders are presented with the opportunity to trade futures on the US dollar currency index. For example, on the ICE intercontinental exchange, he is represented under the DX ticket. Currency traders can also use this tool:
- USDX derivatives are used as an insurance against a sharp movement in the US dollar against other currencies in the basket.
- This is one of the indicators by which investors analyze the general state of the world currency market. It shows how much the trend is stronger in one country compared to other countries (if the dollar rises and the euro falls against other currencies, the graph shows which movement is stronger).
- USDX is used to make money in other markets. As practice shows, most often the direct correlation of the currency index is observed with the Dow Jones, S&P 500 stock indices and the opposite with gold and oil quotes.
Most often, trading is carried out on USDX, which is used as an indicator along with moving averages. Another option is to use divergence. When the divergence (different directions) between the index and the currency pair from the basket is visible on the chart, then, with a high probability, the currency pair will soon change its direction in the direction of the index. That is, the index in this case is the main guiding tool.
It is difficult to call this tool perfect. For example, about 1/5 of the US trade turnover falls on Mexico, but for some reason its currency is not included in the US index basket. But there are no perfect indicators, therefore we recommend it to you as an analytical indicator in trading in any markets. We invite everyone to discuss currency indices in the comments!