Trading any of the seven major currency pairs? You might not want to wholly forget about the US Dollar Index; since it can assist you in forming a spot on directional bias. The index measures the general strength of the US Dollar against a few selected major currencies. Some of the currencies the index is measured against, constitute those from countries which have strong trade relationships with the United States.
Composition of the US Dollar Index
The few selected currencies are the Euro (EUR), Japanese Yen (JPY), Pound (GBP), Canadian Dollar (CAD), Swiss Franc (CHF) and the Swedish Krona (SEK). Actually, the SEK is still regarded as an exotic or emerging currency so it bears no relevance to this lesson.
Of all the major currencies that are weighted against the US Dollar Index, the EUR carries the heaviest weight, followed by JPY, GBP, CAD, SEK and the CHF. According to the Intercontinental Exchange Incorporation, which publishes the index; EUR bears 57.6%, JPY bears 13.6%, GBP bears 11.9%, CAD bears 9.1%, SEK bears 4.2% and CHF bears 3.6% of the weights respectively.
When looking for the US Dollar Index on a trading or charting platform, you are likely to find it symbolized as USDX, DXY or DX. There’s no difference between any of the three symbols. It is also worth mentioning that many of the forex trading brokers have the symbol as USDIndex.
Even though the AUD and NZD are major currencies and are not part of the currencies that make up the Dollar Index; it is still affected by the index because of currency correlation. Gold is also heavily affected because of the same reason.
Therefore, when taking the US Dollar into consideration to formulate trade ideas, the currencies pairs you should be tracking are EURUSD, GBPUSD, AUDUSD, NZDUSD, XAUUSD(Gold), USDJPY, USDCAD, USDJPY.
Using the US Dollar Index (DXY) as a basis for correlation among the major currency pairs.
Since the EUR carries the heaviest weight in the index, the EURUSD is the most affected in relation to the index. It looks as though there is a 100% negative correlation between the EURUSD and the DX. It doesn’t matter the timeframe you’re on; when you pull up a chart of EURUSD and a DX chart, they mirror each other inversely.
As a matter of fact, correlation is a great tool in trading especially when the focus is on currencies. Forex market movements are usually dependent on each other; it becomes obvious to you when you develop the “eagle-eye” to view it. However, it is not always so since it changes from time to time. A least amount of the time, moves that do not make sense from the retail end set in.
When the US Dollar Index is moving up, be rest assured that either EURUSD, GBPUSD, AUDUSD or NZDUSD is moving down. The move down would be strongly affected by the weakest base currency among the four.
Inversely, when the index is trading to the downside, all of the four currency pairs mentioned in the above paragraph will be trading to the upside. Also the strongest amongst the EUR, GBP, AUD or NZD would be the highest gainer.
Correlation between the EURUSD, GBPUSD, AUDUSD, NZDUSD and the Dollar index is pretty simple to track with the eye and a naked chart. However, a little bit of difficulty arises when using the very simple correlation tactic to track the USDCHF, USDJPY and the USDCAD. XAUUSD also belongs to the EUR, GBP, AUD & NZD family but it gets tricky at times.
You might have thought the USDCHF, USDJPY and the USDCAD would all be falling when the US Dollar index is falling and they might be rising when the index is rising. They are supposed to have a positive correlation with the index most of the time by the way.
Risk sentiment can change things for a while.
At a point in time, only one or two out of these three meet the positive correlation to the DX. This happens because CHF and JPY act as safe havens with JPY been the safer haven. When both of these currencies are acting as safe havens because of risk sentiment, then be rest assured that USDCAD is the only pair amongst the three that would be enjoying the positive correlation with the Dollar index.
For the very same reason, Gold’s inverse correlation with the index gets tricky. Gold can also act as an unpredictable safe haven in sentimental moods. The next time you see EURUSD, GBPUSD, AUDUSD and NZDUSD falling whereas XAUUSD is rising smoothly; just know that investors have flown to the safety in Gold as a hedge.
On rare occasions where all the three rise and fall together, the weakest or strongest amongst the CHF, JPY and CAD will determine the biggest gainer or the biggest loser in the USDCHF, USDJPY and the USDCAD.
What many trading educators do not tell you about currency correlation.
The USD factor, is the very reason why new traders are mostly advised to stick with the major pairs; whilst adding the others whilst they progress. I agree with that assertion and this is why.
Imagine, with a deep understanding of the US Dollar Index, Currency Correlation and Risk Sentiment coupled with the technical ins and outs of Price Action; the kind of A+ trade opportunities a new trader would get on only the major currency pairs.
One key thing I must also note is that; the USD is not the only currency that can be used as a basis for correlation. That is one thing many lessons on correlation do not talk about. Whatever be the case, USD correlation is the most popular because of the worldview on that currency.
You can literally take any of the other seven major currencies (EUR, GBP, AUD, NZD, JPY, CHF & CAD); and time their strength or weakness for correlation by using two methods.
- You can visit trading view and pull up charts for the individual indices of the other seven major currencies.
|British Pound (GBP)||BXY|
|Australian Dollar (AUD)||AXY|
|New Zealand Dollar(NZD)||ZXY|
|Japanese Yen (JPY)||JXY|
|Switzerland Francs (CHF)||SXY|
|Canadian Dollar (CAD)||CXY|
- You can simply pair these currencies with the USD, observe the movements and determine the strength or weakness for correlation.
I close the curtain here yet on another valuable trading lesson. Hopefully, you can add this scheme to your trading arsenal; specially towards the major currency pairs and I bet, you would love the progress. Your comments and questions are very welcome below!