DXY is the US dollar index - a tool that investors need to understand

In the modern financial world, if you don’t know about DXY (US Dollar Index), you might be missing an important signal that impacts your portfolio. The Dollar Index measures the strength or weakness of the US dollar against major world currencies. Although many investors don’t track it regularly, DXY is hidden in almost every trading activity and influences gold prices, oil prices, and global stock market returns.

What is the US Dollar Index (DXY) and Why Is It Important?

DXY is a tool that measures the percentage change of the US dollar compared to a basket of six major currencies. This system is designed to give a clear overall picture of dollar movements rather than just comparing it to one currency.

When currencies in the basket (Euro, Yen, Pound, etc.) weaken, the dollar strengthens in comparison, and DXY rises. This simple concept has subtle but significant effects on the global economy that investors often overlook.

Composition of the DXY basket:

• Euro (EUR): 57.6%
• Yen (JPY): 13.6%
• Pound (GBP): 11.9%
• Canadian Dollar (CAD): 9.1%
• Swedish Krona (SEK): 4.2%
• Swiss Franc (CHF): 3.6%

Global investors monitor DXY because it reflects major currency movements affecting the global economy. It also indicates investor expectations regarding US Federal Reserve policies, interest rates, and market risk sentiment.

How is DXY Calculated?

The US Dollar Index uses a weighted formula:

USDX = 50.14348112 × EURUSD^-0.576 × USDJPY^0.136 × GBPUSD^-0.119 × USDCAD^0.091 × USDSEK^0.042 × USDCHF^0.036

While this formula looks complex, the key point is: each number represents the weight of that currency in the basket. The euro has the largest influence because it is the most impactful currency against the dollar.

Factors Driving Changes in DXY

DXY movements are driven by the same factors that influence the dollar: supply and demand.

US Interest Rates

When the Federal Reserve raises interest rates, demand for dollars increases due to higher returns, pushing DXY higher. For example, in 2022, when the Fed increased rates from 0.25% to 4.5%, DXY surged over 12%, reaching its highest in over two decades.

US Monetary Policy

When the Fed implements quantitative easing (QE), increasing the money supply, the dollar tends to weaken, lowering DXY. Conversely, rate hikes tend to strengthen the dollar.

Market Risk Sentiment

The dollar is viewed as a “safe haven” asset during financial crises. When investors worry about war, political conflicts, or economic downturns, they tend to move out of risky assets into dollars, causing DXY to rise.

Central Bank Policies of Other Countries

When the European Central Bank, Bank of Japan, or other central banks cut interest rates, their currencies weaken, which can lead to an increase in DXY since these currencies are part of the basket.

History of DXY Changes Since 1973

The dollar index was created in 1973 to track dollar fluctuations after the collapse of the Bretton Woods agreement.

Early Years: 1970s - 1985

After abandoning the gold standard, the US faced recession and oil crises. DXY declined until the late 1970s, when the Fed raised interest rates up to 20% to curb inflation. From 1980 onward, the economy stabilized, global trade expanded, and dollar demand increased, pushing DXY to a peak of 163.83 on March 5, 1985.

Second Era: 1985 - 2005

Post-1985, DXY fluctuated due to events like the Asian financial crisis in 1997 and the 9/11 attacks in 2001, which increased risk aversion and boosted dollar demand. When the euro was introduced in 2002, investors gained a new diversification option, gradually pushing DXY down.

Recent Years: 2005 - Present

The 2007 subprime mortgage crisis shook confidence in US financial systems. The euro reached $1.47, and DXY fell to a low of 77. To stabilize, the US used QE three times between 2008-2013, weakening the dollar. Since 2015, with the Fed raising interest rates, DXY recovered to around 90-100, but the COVID-19 pandemic in 2020 prompted another round of QE, temporarily weakening the dollar. DXY soared to 114.6 in 2022, then settled at around 101.55 in early 2023 amid US economic slowdown fears and expectations of Fed rate hikes.

Relationship Between DXY and Asset Prices

Because the dollar is the global benchmark for asset prices, DXY has strong correlations with commodities, stocks, and other assets.

DXY and Commodities

Inverse relationship: when DXY rises (dollar strengthens), foreign buyers need more dollars to buy gold, oil, or agricultural products, pushing prices down. When DXY falls, commodity prices tend to rise.

DXY and Stock Markets

When DXY increases, capital may flow back into dollars from other markets to lock in gains, reducing returns elsewhere. Conversely, a falling DXY can boost other markets.

DXY and Other Currencies

Currencies in the basket (Euro, Yen, etc.) tend to move inversely to DXY. For example, if the euro strengthens, DXY tends to decline because the euro has a 57.6% weight in the basket.

Long-term Technical Analysis of DXY

Weekly charts show DXY reaching a high of 114 before gradually declining. RSI indicators suggest potential further correction. Currently, DXY hovers around 101, with support levels near 100 and 96. Future movement depends on US economic data and Fed signals.

3 Investment Strategies for the US Dollar Index

If you want to profit from DXY movements, here are some options:

1. Spot USD Purchase

The traditional method: exchange your local currency for dollars and hold. When the rate moves favorably, exchange back. Pros: actual dollar holdings. Cons: limited short-term profit margins. Suitable if you already need dollars.

Minimum: $50 | Risk: Low | Time horizon: Long-term

2. Invest in Foreign Money Market Funds

Funds managed by professionals, easy to buy and sell via accounts. Benefits: low entry, profit from USD appreciation against your local currency. Drawbacks: only one trading per day, limited short-term gains. Suitable for medium to long-term investing.

Minimum: 100 units of local currency | Risk: Low to medium | Time horizon: Medium to long-term

3. CFD Trading (High Risk)

Contracts for Difference (CFD) allow short-term traders to trade DXY directly without currency conversion. Leverage enables small investments to profit from small price movements, with the ability to profit both rising and falling markets.

Cons: very high risk, complex instruments, leverage can wipe out your capital. Requires thorough understanding before trading.

Minimum: $50 | Risk: Very high | Time horizon: Short-term

Summary

DXY is a highly influential indicator in global finance. Even if many investors don’t follow it directly, understanding what DXY is helps you better anticipate asset price movements across gold, stocks, and currencies.

Investors seeking to profit from the US Dollar Index can choose strategies aligned with their risk tolerance and investment horizon—from simple currency exchanges to complex CFD trading. When considering DXY, remember it’s not just a number on a screen but a vital tool guiding the complex world of finance.