Trading EUR/USD With The USD Dollar Index

What is your market sentiment on the US Dollar (USD)? Is it gaining strength or getting weak? US Dollar Index measures the strength of USD against a basket of currencies. This basket of currencies comprises the EURO (57.6%), Japanese Yen (13.6%), British Pound (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%) and Swiss Franc (3.6%).

US Dollar Index symbol is $DXY and is popularly known as the Dixie. US Dollar Index Futures contracts get traded on the ICE Futures Exchange formerly the New York Board of Trade (NYBOT). One thing you must have observed is that this index is heavily weighted against the EURO. This is due to the fact that before the EURO inception, this index contained the French Franc, the German Mark, Italian Lira and other European currencies. But when EURO came into existence as the single currency of the EMU in 1999, it replaced all the above currencies. Hence, the heavy tilt against this single currency.

One thing that you must know is that USDX is heavily tilted in favor of the EURO. So, you can use it in trading the EUR/USD pair. USDX measures the strength of USD while EUR/USD measures the strength of EURO. What this means is that the US Dollar Index and the EUR/USD move in opposite directions.

You must have observed that the US Dollar Index is heavily tilted towards the EURO something like more than 50% of the weight has been assigned to this single currency in the index. What this means is that this index can reflect the movement of the EURO currency in the market up to some extent. EUR/USD pair moves with the EURO. We can use the US Dollar Index in trading EUR/USD pair. As said above, USDX and the EUR/USD pair move in the opposite directions. Suppose, you are trading EUR/USD on a daily chart! You find it in an uptrend about to hit an area of support. You check with USDX chart. As both USDX and EUR/USD move in an opposite direction, USDX should be in a downtrend with close to hitting an area of resistance. If you confirm this observation on the USDX chart, you can enter into a EUR/USD long trade.

Let's take another situation where the US Dollar Index tells you not to enter into a EUR/USD trade. Suppose, EUR/USD pair is on a verge of a breakout on the daily chart! A nice, head and shoulder pattern is being formed on the EUR/USD chart. EUR/USD is on a long term uptrend. So, you expect a downtrend to breakout now. This means bulls for the USD.

You check your observation on EUR/USD chart by taking a look at the USDX weekly chart. USDX is also showing an uptrend with a head and shoulder formed meaning a new trend in the down direction. When USDX moves down, it means the market is bearish on USD.

EUR/USD chart indicates a bullish USD while US Dollar Index Chart indicates a bearish USD. Both these observations are contradicting each other. Don't enter into a EUR/USD short trade. This is how you can use the US Dollar Index in trading EUR/USD pair. Good Luck!

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