You must have heard about the famous DOW Index and the S&P 500 Index. But have you ever heard about the US Dollar Index. Just like these stock market indices, USD Dollar Index is used to measure the strength or weakness of US Dollar (USD) against a basket of currencies. This index is very helpful in forming USD market bias against a number of highly traded currencies. The basket of currencies involves the EURO, JPY, GBP, CAD, SEK and CHF. SEK is the Swedish Krona. This basket is heavily tilted towards the EURO which comprises 57.6% of the basket weight.
US Dollar Index symbol is $DXY and is popularly known as the Dixie. US Dollar Index Futures contracts get traded on the ICE Futures Exchange formerly the New York Board of Trade (NYBOT). One thing you must have observed is that this index is heavily weighted against the EURO. This is due to the fact that before the EURO inception, this index contained the French Franc, the German Mark, Italian Lira and other European currencies. But when EURO came into existence as the single currency of the EMU in 1999, it replaced all the above currencies. Hence, the heavy tilt against this single currency.
How can you use USDX in forex trading? Pro traders use USDX in diversifying their spot USD trades. Now, as said above, USDX is heavily tilted in favor of the EURO more than 50%. It is often used to trade EUR/USD. Both the EUR/USD and the USDX move in opposite direction. When EUR/USD rises, USDX falls. You should know this fact.
You must have observed that the US Dollar Index is heavily tilted towards the EURO something like more than 50% of the weight has been assigned to this single currency in the index. What this means is that this index can reflect the movement of the EURO currency in the market up to some extent. EUR/USD pair moves with the EURO. We can use the US Dollar Index in trading EUR/USD pair. As said above, USDX and the EUR/USD pair move in the opposite directions. Suppose, you are trading EUR/USD on a daily chart! You find it in an uptrend about to hit an area of support. You check with USDX chart. As both USDX and EUR/USD move in an opposite direction, USDX should be in a downtrend with close to hitting an area of resistance. If you confirm this observation on the USDX chart, you can enter into a EUR/USD long trade.
In the above example, USDX confirmed your trading signal on EUR/USD. Suppose, EUR/USD chart shows the price action about to break out in a new direction. You find a head and shoulder chart pattern forming on the EUR/USD intraday chart. The trend is up! This means a new trend in the down direction with high probability should be expected. When EUR/USD moves down, it means USD appreciates or the market is bullish on USD.
You take a look at the USDX chart. It is also in an uptrend and on a verge of a breakout with a nice head and shoulder pattern formed. This means a possible downtrend for the US Dollar Index. In other words, a weakening of the USD or bears for USD.
Now, EUR/USD chart is giving a bullish outlook on USD while the USDX chart is giving a bearish outlook on USD. Both these signals are not confirming each other. So, stay out of a EUR/USD short trade.
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