The DXY or US Dollar Index is an index that is used by investors to measure and understand the relative value of the U.S. dollar when compared to other currencies in the world. This index has been used by analysts and investors as it helps them understand whether the dollar is overvalued or undervalued compared to other currencies.
In this guide, we tell you all the details about the DXY index and how it works. Moreover, we will get into how investors could use it to analyse the forex market and understand the different relationships that exist between different currencies.
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As we mentioned in the introduction, the DXY Index is an index that measures the relative strength of the US Dollar compared to other currencies in the world. When the value of the index moves higher, it shows that the U.S. dollar relative value is growing. The contrary would happen if the index starts moving lower.
When the index was created, the goal was to measure the value of the U.S. dollar with some of the most important trading partners of the United States. In this way, it was possible to understand possible forex anomalies and also understand whether trading relationships could deteriorate or improve for the U.S. and other countries.
At the moment, the index is maintained and published by the Intercontinental Exchange (ICE) and it is known as the U.S. Dollar Index. In sum, the U.S. Dollar Index is a weighted geometric mean of the U.S. dollar valued compared to other currencies. We will get into the details about which currencies are used in the next section.
Let's now try understanding how the DXY Index works. The first thing we should know is that it takes into consideration 6 different currencies from different countries that were considered to be major U.S. trading partners in the past.
These currencies include the following:
Each of these currencies has a specific weight on the index and not all of them are measured in the same way. What does it mean? The Euro has 57.6% weight, the Japanese yen has a 13.6% weight, the Pound has an 11.9% weight, the Canadian dollar has a 9.1% weight, the Swedish krona has a 4.2% weight and the Swiss franc has a 3.6% weight.
This is how the value of the DXY Index is calculated. It takes into consideration some of the largest currencies in the world and makes a weighted geometric mean of the U.S. dollar value.
However, there have been some critics that believe that the U.S. Dollar Index should have and include other currencies such as the Mexican Peso (MXN) or the Brazilian Real (BRL), two currencies that are currently used by countries that are major trading partners of the United States.
Hence, the DXY dollar index has also its limits, as it does not take into consideration of other currencies that could be very important to understand the relative value of the largest currency in the world.
Of course, as an index, we see that its value fluctuates according to different economic situations. The main question is whether it is possible to invest in the DXY index. You can trade the DXY Index as any other equity index that you can find in the market. Usually, this is a very competitive market that lets users get access to one of the most interesting and potentially profitable trades.
You can trade this market by using different indicators as if you would be investing in other assets. The goal is to identify possible changes in the trend of the U.S. Dollar Index and make profits with medium-term trend changes.
Remember that the DXY Index measures specific currencies. Thus, you should understand the situation that takes place in some of these markets to analyse the performance of the U.S. dollar index and its future price performance.