by Andrew Horowitz

We've spent the last couple of episodes talking about the Forex market, and now we will simplify that and just talk about the U.S. Dollar Index. Have you ever heard people on TV or on websites talk about the U.S. Dollar Index and wondered exactly what that meant? You're not alone!

What is the US Dollar Index?

If we want to look at the value of the dollar, we use the Dollar Index, which compares a basket of currencies to the dollar to give us a general feel for whether the greenback--that's another word for the U.S. dollar--is getting stronger against other foreign currencies as a whole or whether it is getting weaker. When the dollar gets stronger, it means that our dollar can be converted into more of the foreign currency, like the euro or British pound. 

Like the Dow Jones is an index of 30 carefully selected stocks to reflect the strength or weakness of the U.S. stock market, the U.S. Dollar Index is a carefully selected index of six major Forex pairs, which are 2 currencies that are compared against each other. Remember, a currencies value is always in relation to another currency.

Which Currencies Make Up the U.S. Dollar Index?

Here are the following six currencies that make up the U.S. Dollar Index, along with the percentage of these Forex pairs (against the U.S. dollar) percentage weighting that we call the Dollar Index:

• Euro:  58%

• Japanese Yen:  13.5%

• British Pound Sterling:  12%

• Canadian Dollar:  9%

• Swedish Krona:  4%

• Swiss Franc:  3.5%

What is the Value of the U.S. Dollar Index?

In 1973, when economists started tracking the U.S. Dollar Index, they set it up with a strating value of  100--The value of the index has risen as high as 165 and all the way down to a low just under 71.

Can you guess when the low of 71 was hit? 

The U.S. Dollar Index traded at its lowest level on March 16th, 2008--that was when the dollar index was at its weakest point while other foreign currencies were stronger than the dollar. 

The index peaked just shy of 90 in March 2009 and spent the rest of 2009 falling back close to its 71 index value lows.

Why Pay Attention to the U.S. Dollar Index?

In addition to knowing just how strong or weak those dollars in your wallet are  compared to foreign currencies, analysts and investors can compare the trend or direction of the U.S. Dollar Index to other commodities such as gold, bonds, or crude oil.

In general, as the U.S. Dollar Index goes down, gold and crude oil prices go up, so we would say that the U.S. Dollar Index is inversely correlated with commodities. 

How are the U.S. Dollar Index and the Stock Market Related?

You may have heard a lot on the news recently about the U.S. Dollar Index and the stock market also being inversely correlated, meaning that when the U.S. Dollar Index goes down, the stock market goes up. That has certainly been the case since the stock market lows of March 2009! It certainly seems counter intuitive that as stocks go up, the Dollar Index goes down, but that has certainly been the trend over the last few years.

You can look at the current price and trend of the U.S. Dollar Index by typing in symbol $USD in StockCharts.com, or in your favorite online charting program or financial website. Pay attention to the trend or direction of the index over the last few months or even years to get a bigger perspective of how the index has been moving.

The Dollar Index is helpful to watch the strength of the U.S. Dollar, but you can't trade the Dollar Index  directly, you have to use an investment vehicle.

In another episode, we will learn about exchange-traded funds that track currencies and how you can use ETFs to act like the Dollar Index so you can add currencies to your portfolio with ETFs instead of learning all the rules of trading Forex.

Keep with us as we discuss even more ways to become a winning investor in our next article! If there’s a question you’d really like to ask, just email me at winninginvestor@quickanddirtytips.com
 
Until next time, this is Andrew Horowitz with The Winning Investor’s Quick and Dirty Tips for Making Money in Any Market  wishing you all the best on your quest to investment success.