Currencies

What You Need to Know: The Dollar Index

Stock quotes in this article: UUP , UDN  

NEW YORK (TheStreet) -- With all the recent talk about inflation and dollar weakness, there's been lots of interest in the U.S. dollar index (USDX).

This index is an important tool for traders in just about every market -- not just currencies -- so we thought we'd provide our readers with a comprehensive primer on it.

The U.S. Dollar index is actually a futures contract, which means that if you have a futures trading account you can trade the index the same way you trade corn, oil, gold and currency futures contracts.

However, most retail traders don't trade the futures contract. Rather, they use the index as a way to analyze the strength of the greenback in general.

The USDX compares the dollar against a basket of some of the world's largest free-floating currencies on a weighted-average basis. The currencies included are the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc. Each is given a weight within the index, and the euro has the largest weight.

The euro is typically half the total weight included in the average chart for the USDX, so often a chart of the index will look a lot like like a chart of the dollar/euro futures contract.

Observers of the spot forex markets will note that the USDX is also very similar to the inverse of the euro/dollar forex pair. However, because the USDX includes six different currencies, it's a better measure of the dollar's strength than any single currency pair, including the euro/dollar.

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