When trading in the forex market, investors have to choose two currency pairs to work upon. And the currency that is most commonly paired with other the currencies is the US dollar. By definition, the US dollar index is the measure of the value of the US dollar against most of its currency partners.
The US dollar index is actually composed of six other currencies. These are the Euros, Japanese Yen, British Pounds, Canadian Dollars, Swedish Krona, and Swiss Francs. There are only six currencies that affect the US dollar index but there are a total of 22 countries that are in play. This is because the value of the Euros is directly affected by its 17 member states. In essence, any changes in the market of any of the European Union member nations affect the overall performance of the Euros currency.
As such, each of these currencies is given a specified weight average when computing for the US dollar index. Since the Euros are composed of 17 member nations, it is given the biggest weight. The Euros makes up 57.60% of the computed US dollar index. It is followed by the Japanese yen at 13.60%, then by the British Pounds at 11.90%. The other three currencies follow suit, which are the Canadian Dollars at 9.10%, the Swedish Kronas at 4.20%, and Swiss Francs at 3.60%.
The US dollar index is calculated for 24 hours a day within a period of five working days. The index is updated as the US dollar market opens and that would be Sunday evening until Friday afternoon New York Time. The index is measured in relative to the 100.000 base. An 87.231 US dollar index value means that the index has fallen down 12.769% since the start. On the other hand, if the reading becomes 125.332, it means that its value has risen some 25.332% since then. When the US dollar index goes up, it only means that the US dollar has gained strength against the other currencies.
Technically, the start of the index that investors refer to is March 1973. The US dollar index is calculated since that fateful day in 1973 when the biggest nations of the world convened at Washington DC and agreed to let their currencies freely float against each other. The start of the index is also alternately called as the base period.
Aside from the crucial role of the US dollar index in the Forex market, it can also be traded as futures at the ICE. It is also available in mutual funds and ETF options. A certain formula is used to compute the US dollar index and it involves the current market value of the six currencies in play multiplied by their weighted geometric averages.