US Dollar Index Chart – Why Use It With Forex?

Dollar Index Chart – Barometer Of  Trading Conditions

For those of you that are unaware, the US dollar index measures the relative strength of the USD against 6 other currencies that are the trading partners of the United States.  Inside that basket of currency pairs, the EURUSD makes up the bulk of the measure.

The top 3 currency pairs that make up the Dollar Index chart are:

1. EURO
2. Japanese Yen
3. British Pound

The Dollar Index is a good barometer of the strength or weakness of the USD against other currency pairs although the trade-weighted Index, it could be argued, is more relevant to the true strength of the USD.

Adding the knowledge of the technical conditions of the Dollar Index can be part of your overall trading plan and help you assess which direction you wish to trade.

This is the current long term weekly Dollar Index chart and while the price is moving upwards, we have been in a trading channel for over a year.

While not a great trending move, we do see that over time, the USD against the basket of currencies holds a stronger edge.

The USD is considered a safe-haven currency.  In times of economic uncertainty, the index will rise but will also rise when the U.S economy is doing well.

EURUSD & Dollar Index

The Euro makes up over 50% of the measurement of the USD strength of weakness.  If you trade the EURUSD, you would be wise to incorporate the Dollar Index as they move in the opposite direction.

Notice the EURUSD was climbing as the index was falling.  If we look at current market conditions, both are trading inside of a channel.

How would you incorporate this information into a trade?

Is This A Breakout?

Here we have the weekly EU chart with the index as an inset chart.

Both charts are similar:  One market is trying to take out highs while the other is looking at lows.

While you would stick to a trading plan, you’d want to use the index as the key indicator for the movement of the USD.  In this case, EURUSD traders, due to the channel of the index, would look to fade this attempted breakout of the EURUSD.

Dollar Index Chart Trading Strategy

You can trade the index just like you would any other index such as the S&P.  The strategy you would use would not be much different than any other instrument.

• Determine the direction you want to trade
• Enter the market when your setup appears
• Manage the trade and exit when your signals indicate a change of direction

This is a simple trading strategy that will use a technical analysis approach with a higher time frame.  We will also implement the following indicators:

• Two EMAS 8, 21
• RSI 21 and the 50 level
• MACD 12,26,9

This is the daily Dollar Index chart using the channel lines from the weekly chart.  Also, consider a trending price structure to ensure you are not being overly affected by the lag in technical indicators.

The green lines are trade entry zones for long trading signals:

1. Moving averages have crossed to the upside
2. RSI is above 50
3. MACD has had a bullish crossover
4. Entry can be made on MACD cross, RSI moving above 50 or the moving average crossover
5. You can also use breaks of swing highs

The red lines are short trades:

1. Moving averages have crossed to the downside
2. RSI is below 50
3. MACD has had a bearish crossover
4. Entry can be made on MACD cross, RSI moving above 50 or the moving average crossover
5. We can also use breaks of swing lows and failure test entries as noted with the red arrow.

This is not a complete trading strategy as there are some nuances that have to do with reading price action.  It will give you a solid foundation to begin designing a trading strategy for the US Dollar index.

Even if you do not trade the actual index, knowing the state of it can enlighten you to trading opportunities on the other currency pairs in the basket.

Some will ask what is the best Forex trading system to use the index with?  There is no best but there is having an edge and that is what you should look for.

Wrap Up

Forex does not have a central exchange where we can get accurate readings about volume.  The Dollar Index will show the strength of the USD against the main trading pairs.

We can use that information, USD strength or weakness, to help determine the trade direction and opportunity when a currency pair sets up.

You can also use your trading strategy to trade the USD index directly.