Don’t worry if that fluctuating figure on the US Dollar Index is confusing you, too, like me. This article has your back; as we know, figuring out the strongest currency is a bit of a tiring task but not that hard. With easy steps, we will learn how to read the US Dollar Index to understand it easily whenever needed.
Before understanding, know what the US Dollar Index is. The US dollar index is a standard index used to compare the value of the US dollar with otherworldly currencies in trade specifically.
For example, 90% marks are the cutoff for admission to a college, then
90% is the standard figure to compare. Similarly, there is a US dollar Index to compare against other major currencies in trade.
Now, what you see on opening the US Dollar Index is the Dollar Index chart, a fluctuating graph displaying the rise and fall of the dollar. A dollar index chart is what we need to understand. Let’s dive in.
Things To Note Beforehand
- The US Dollar Index’s base value is 100.00, i.e., values are calculated out of 100.00.
- The value of the US Dollar is calculated against six foreign currencies in trade, which are the Euro (EUR), Canadian Dollar, Swiss Franc(CHF), Japanese Yen(JPY), Swedish Krona(SEK), and British Pound (GBP).
- The index is calculated 24 hours a day and five days a week.
How To Read US Dollar Index!! Understanding the Maths
The dollar index is formed by the average weight of all six countries. The average weight each country holds in the US dollar index chart is –
Euro (EUR)- 57.6%
Japanese Yen (JPY)- 13.6%
British Pound (GBP)- 11.9%
Canadian Dollar(CAD)- 9.1%
Swedish Krona (SEK)- 4.2%
Swiss Franc (CHF)- 3.6%
From the above section, we can see that the euro has the highest weight in the index. In correlation, when the US index falls, the Euro.USD exchange rate rises.
For example, if the current value of the US dollar is 80, that means it has depreciated by 20%, given the base value is 100. The loss suffered is calculated as 100-80. Simple right? Just like your school maths.
The other case is if the dollar’s value is 120 currently, it has appreciated or increased against the basket of countries involved. How much increase is there now? It is 20%. Always remember the base value, i.e., 100; a 20% increase is calculated as 120-100. Huh!! So simple.
Suppose I have to say in layman’s terms. In that case, a figure above 100 is the appreciated value of the dollar, or the US dollar is performing well against other currencies, and a figure below 100 is the depreciated value, or you can say the US dollar is performing low.
Both strengthening and weakening dollar impact international trade, foreign investments, and exchange rates. Above all, it tells us about inflation. Analyzing a dollar index helps investors and traders know the latest market trends.
Formula To Calculate the US Dollar Index
If you are geeky, you will attempt this formula. The above-given idea is in general terms where you can interpret dollar value just by looking at the graph. However, for a deeper understanding, there is a formula as well-
USDX = 50.14348112 × EUR/USD^(-0.576) × USD/JPY^(0.136) × GBP/USD^(-0.119) × USD/CAD^(0.091) × USD/SEK^(0.042) × USD/CHF^(0.036)
USDX is the abbreviated form of The US Dollar Index.
Trading The US Dollar Index
The US dollar index is a popular way investors or traders can enter the US economy or the global market. The US Dollar Index allows traders and investors to keep track of the currency’s performance. They use this to avoid risk- -exposure, considering profits and losses from the rising or falling dollar value.
Analyzing the index, participant investors or traders buy and sell the US dollar index futures contract. A US Dollar Index futures contract is an agreement to buy or sell a product or a commodity by one party to another in the future. These futures are traded on the ICE platform for 21 hours a day.
History Of The US Dollar Index
The U.S. dollar index was introduced by the U.S. Federal Reserve back in 1973 only to analyze the growth or performance of the U.S. dollar against other countries after the Bretton Woods agreement collapsed. Later, the index was revised to consider the economic patterns and importance.
The maximum value the US dollar reached was 165 in 1984, and the lowest it went to was 70 in 2007. But if we see the growth of the US dollar in the last few years, it ranges between 90 to 110.
Reasons For The Rise And Fall Of The US Dollar
A few reasons that affect the growth of the dollar are Inflation, Currency demand, Movements in Fed
Inflation is defined as when prices of products in a certain period go very high. When this happens, a country loses its purchasing power. Inflation decreases demand as rising costs of products become a factor for other countries to avoid imports. Similarly, the opposite case of this will reflect an increased dollar value.
Movements In The Federal Reserve System
The dollar’s value greatly depends on the decisions of the US Federal System. If the Fed raises its interest, the potential investors and markets will be attracted to invest in the US economy, resulting in the currency’s rise. For example, in the last two years, the Fed increased its interest rates by eight times to control inflation. Conversely, the value of the US dollar will fall if the interest rate is lowered.
Demand for currency happens concerning a country’s exports. The more there is demand for products from the US, the more the currency demand is because global buyers or consumers convert their local currency into dollars by selling their currency.
The US dollar is undoubtedly the strongest currency and a topic of discussion. It becomes important to understand its basics, as we helped you to do so in this article. Ending this write-up, I hope The US dollar index won’t confuse you in the future.
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