Basic Knowledge About DXY – The US Dollar Strength Index

What is the DXY Index?

The DXY Index measures the value of the US Dollar against the currencies of six of the most significant trading partners of the United States.

History of the DXY

The DXY Index was first introduced in 1973, right after the Bretton Woods system (a system established in 1944 that created a fixed exchange rate regime built around a USD peg to gold) was dissolved, with an initial value of 100.00.

The Bretton Woods system laid the foundation for fixed exchange rates and the gold standard, starting in 1944 and ending in 1973.

Amid concerns about the overvaluation of the USD leading to exchange rate issues, President Richard Nixon temporarily suspended the gold standard, allowing other countries to choose any exchange method other than gold. In 1973, many foreign governments opted for floating exchange rates, ending decades of adherence to the Bretton Woods agreements.

Basic Knowledge About DXY - The US Dollar Strength Index
American flag and banknotes (USD) currency money background

The current DXY Index is calculated using the following formula:

The Euro (EUR) remains the most heavily weighted component of the DXY formula, accounting for 57.6%. The weights of the other currencies in the index are:

  • JPY (13.6%)
  • GBP (11.9%)
  • CAD (9.1%)
  • SEK (4.2%)
  • CHF (3.6%)

The US Dollar Index has fluctuated throughout its history, peaking at 164.72 in February 1985 and hitting a low of 70.698 in March 2008.

As of March 25, 2020, the index stood at 100.35, indicating that the USD had depreciated relative to the basket of currencies since 1985 but had returned to its original value from 1973. The index is heavily influenced by macroeconomic factors, including inflation/deflation of the dollar and the currencies in the basket, as well as economic recessions and growth in those countries.

The composition of the currency basket has been changed only once, in 1999, when the Euro replaced several former European currencies, such as the Deutsche Mark. In the coming years, it is likely that the components of the basket will be adjusted as the DXY tries to represent the major trading partners of the United States. It is possible that the Chinese Yuan (CNY) and the Mexican Peso (MXN) will be added to the basket, as China and Mexico are major trading partners of the US.

How to Analyze and Trade the DXY

If the DXY reaches a value of 120, it means that the US Dollar has appreciated by 20% relative to the basket of currencies. Simply put, if the DXY rises, it indicates that the strength or value of the US Dollar has increased compared to other currencies. Conversely, if the DXY is at a value of 80, it means it has depreciated by 20%.

The US Dollar Index allows traders to monitor the value of the USD against a selected basket of currencies in a single transaction. It also allows for hedging risk if you have assets or positions related to the US Dollar, through DXY futures or options contracts. These financial products are currently traded on the NYBOT (New York Board of Trade). Investors can use the index for hedging or speculation purposes.