How to Trade the US Dollar and the Dollar Index

The US dollar is the world’s best-known currency. It is used around the world for trade and most governments hold it as a reserve currency. It is also one of the most stable currencies in the world.

In this report, we will look at how you can trade the US dollar as a currency. We will also look at the US dollar index, which is an important benchmark that tracks the performance of the greenback.

What is the US dollar index?

The US dollar index (DXY) is a popular benchmark that measures the performance of the dollar. It does this by comparing the dollar’s performance against a basket of currencies like the euro, pound, and yen.

Most of the weight is in the euro, which makes up about 57.6% of the index. It is followed by the Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. As such, if the dollar gains against the euro by a large margin, the index will rise and vice versa.

The US dollar index rose sharply in March 2020, when the World Health Organisation (WHO) named the coronavirus a global pandemic. It rose sharply because, at the time, investors, traders, and businesses were rushing to the safety provided by the dollar. As the number of cases fell and as the probability of a vaccine increased, the US dollar index started to drop.

What moves the US dollar?

A common question is what determines the strength or weakness of the US dollar. Unlike most currencies, there are several reasons why the dollar becomes strong.

Global Crisis

First, like during the coronavirus pandemic, the dollar gets strong in times of a global crisis. Indeed, the currency strengthened during the dot com bubble, the Global Financial Crisis, and during the coronavirus pandemic.

The FED

Second, it strengthens because of the Federal Reserve. A hawkish Fed tends to lead to a stronger dollar while a dovish Fed tends to lead to a weaker greenback.

Other Currencies

Third, the dollar index gains because of the economy of its constituent currencies. For example, in recent months, the dollar has declined because of the perception that the European economy will have a faster recovery than in the US.

Consequences of a strong or weaker dollar?

There are two main aspects of a weaker or stronger dollar. First, a weaker dollar is usually a positive thing for American companies that do a lot of exporting. This is because it makes their products and services cheaper to their international markets.

As shown in the chart below, the S&P 500 tends to fall when the dollar gains.

Second, a weaker US dollar tends to be beneficial to assets like precious metals and cryptocurrencies. That is because these assets are usually priced in dollars. Therefore, when the dollar rises, their prices fall as well.

How to trade the US dollar

As mentioned above, there are two primary ways of trading the US dollar. First, you can trade the US dollar index, which is usually offered by most trading platforms. Second, you can trade currency pairs that have the dollar.

Among the most popular pairs to trade the dollar are:

  • EUR/USD – This is the most popular and most liquid currency pairs in the world.
  • GBP/USD – The sterling to dollar pair is among the oldest currency pairs.
  • USD/JPY – The USD/JPY pair is also very liquid because of the size of the US and Japan economy.

Other popular currency pairs to trade the US dollar are USD/SEK, USD/TRY, and AUD/USD.

Where to find relevant news about the US dollar

To trade the US dollar, it is usually important to have relevant and most recent news. This includes the most recent political news and economic data. Some of the most prominent news sources are usually premium, meaning that you need to pay for them.

These include Bloomberg Terminal and Reuters Eikon. As a basic trader, there is no need to pay for these platforms, which cost more than $1,800 per month. As a trader, popular sources of good US dollar related news are Investing.com, Market Chameleon, and Benzinga, among others.

Top Free Sources to Find Quality Financial News

Final thoughts

The US dollar is the world’s most important currency. It is used as the world’s reserve currency and it is also the most popular currency in cross-border transactions. Therefore, as a trader, it is important for you to understand how the currency works, what makes it move, and how to trade it.

External Useful Resources

  • Why the US Dollar Is the Global Currency – The Balance
  • Dollar Is Trading at a Discount for First Time Since March Chaos – Bloomberg

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