This chapter allows the reader to build a base of knowledge on how to follow the U.S.
dollar and how to use it in trading forex.
The U.S. Dollar – Closer Look
The U.S. dollar is considered the “reserve” currency of the world because the United States is the largest economy in the world. Before you decide to trade a particular currency pair, it makes sense for you to follow the value of the U.S. dollar and know where to look to track that value.
U.S. Dollar Trade-Weighted Value
Changes in the value of the U.S. dollar really depend on your perspective. Economists have developed the concept of a trade weighted dollar index to enable measurement of dollar trends based on the mix of imports and exports. It’s called weighted because the mix of exports and imports in countries differs greatly. For example, Japan exports
25% of its goods to China, and Canada exports 50% of its goods to the United States. The trade-weighted index more accurately reflects export patterns.
There can be many trade-weighted dollar indexes. In fact, each state can develop its own trade-weighted index to refl ect its trading relationships with countries. The California trade-weighted index would be different than that of North Carolina because the states produce different commodities. What is important to realize is not the exact formula that the Fed Reserve uses but the meaning of the chart. The key question is: What is the trend direction of the U.S. dollar in the world economy?
US Dollar Index (USDX)
On a day-to-day basis, forex traders can look to the U.S. Dollar Index ( USDX) to gain a sense of global sentiment regarding the dollar.This index, traded on the New York Board of Trade (NYBOT), consists of a trade-weighted geometric average of six currencies. According to the NYBOT, the USDX is currently computed as:
Note: Please see Abe’s book “Understanding Forex: Trading to Win” for the remainder of the chapter. Copies can be obtained from the Freebie section of forexhound.com