The US Dollar Index For Spot Forex by Joseph James Gelet
The US Dollar Index is a tool that forex traders can use, but do you know its value?
When traders hear about the “dollar index” in the news, it’s logical they assume it has something to do with currencies. However, the dollar index — that’s the “US Dollar Index” — is actually a basket of currencies that trades as a futures contract. This is a currency derivative, deliverable with physical currencies based on your position at contract expiry. The value of the futures contract is a weighted geometric mean of the US dollar against the euro, yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. Before the creation of the euro, the dollar index included 10 currencies. No longer included in the mix are the Italian lira, the Dutch guilder, the Belgian franc, the French franc, and the Deutschemark.
Currencies are often grouped with futures and this is often an inappropriate association, as futures contracts are vastly different from foreign exchange contracts. Primarily, forex is traded through banks and other counterparties, whereas futures contracts are traded on an exchange. There are other technical differences in how a contract is traded, such as standardized size, margins, availability, and regulation.
In this article I’ll explain why the dollar index should be used by spot forex traders as an anchor indicator similar to gold, and I’ll also explain why spot forex traders should develop their own value of the dollar index based on spot forex prices, creating their own “forex synthetic.”
TRADE-WEIGHTED DOLLAR INDEX
There is another index called the “trade-weighted US dollar index,” also known as the “broad index.” It includes 27 currencies and it was created in 1998 by the Federal Reserve as a more accurate method of tracking the value of the dollar, and also because the euro would end the previous components of the dollar index.