How To Use The US Dollar Index In Trading EUR/USD Pair?

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Published: 03rd November 2010
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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.

Now, forex traders often use this index to help diversify their trades involving USD by hedging the USD spot trades. US Dollar Index is especially helpful in trading the EUR/USD pair since the index involves more than 50% EURO weight in measuring the strength of USD. One thing you must observe is that this index moves with the USD meaning when USD gains strength it rises! On the other hand, the pair EUR/USD moves with the EURO meaning when EURO goes strong it moves up. So, both the USDX and the EUR/USD move in opposite direction.

So, how can we use the USDX in trading EUR/USD pair, the most popular pair amongst the forex traders. Suppose, you find EUR/USD in a downtrend on the intraday chart like the 60 minutes chart. EUR/USD pair is hitting resistance on the 60 minutes chart. You check up on the USDX chart. The US Dollar Index is in an uptrend. Remember, both move in the opposite directions. USDX is hitting support. This is a good confirmation that you can go short on the EUR/USD pair.

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.

Both these signals are contradicting themselves. EUR/USD chart is bullish for USD while the USDX chart is bearish for the USD. Don't enter into a trade. This is the time to hold your trigger. So, when trading EUR/USD it is a good way to get confirmation from the US Dollar Index.


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