Article by Ahmad Hassam
What is your market sentiment on the US Dollar (USD)? Is it gaining strength or getting weak? US Dollar Index measures the strength of USD against a basket of currencies. This basket of currencies comprises the EURO (57.6%), Japanese Yen (13.6%), British Pound (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%) and Swiss Franc (3.6%).
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.
How can you use USDX in forex trading? Pro traders use USDX in diversifying their spot USD trades. Now, as said above, USDX is heavily tilted in favor of the EURO more than 50%. It is often used to trade EUR/USD. Both the EUR/USD and the USDX move in opposite direction. When EUR/USD rises, USDX falls. You should know this fact.
How to use the USDX in confirming a EUR/USD trade setup? Suppose, EUR/USD pair is hitting support on the 4 hour chart! You check the USDX 4 hour chart, it should be hitting resistance. Both the charts move in opposite direction. You check on the daily chart, EUR/USD is in an uptrend. This is a good trade confirmation that you can go long on EUR/USD.
Now, we take a situation where just by looking at the USDX chart we know that it is not a good time to trade EUR/USD. Suppose, EUR/USD has been trending for a long time and is on the verge of a breakout! You find a the head and shoulder pattern forming nicely. This means that market has reached its top and a downtrend will soon develop or will it. You need a confirmation.
You check your observation on EUR/USD chart by taking a look at the USDX weekly chart. USDX is also showing an uptrend with a head and shoulder formed meaning a new trend in the down direction. When USDX moves down, it means the market is bearish on USD.
EUR/USD chart indicates a bullish USD while US Dollar Index Chart indicates a bearish USD. Both these observations are contradicting each other. Don’t enter into a EUR/USD short trade. This is how you can use the US Dollar Index in trading EUR/USD pair. Good Luck!
About the Author
Mr. Ahmad Hassam has done Masters from Harvard University. Learn this powerful Fibonacci Retracement method FREE that pulls 500+ pips per trade! Get these 3 Swing Trading Systems FREE.