Using the indices to help track the direction of the major pairs
Part of my FX trading regime at the beginning of each week, and of each day, is to assess and monitor the 2 major indices, the USD dollar index (USDX) and the Euro dollar index (EURX). I find this useful to help with determining the possible trend directions on the major FX pairs. For example, if the USDX is trading up then I would look towards being ‘Long’ on the USD and short on the currencies that make up this index.
Description of the components of the USDX and the EURX
The US Dollar Index (USDX) is a measure of the value of the US dollar compared a basket of foreign currencies. It is a weighted mean of the dollar's value compared to
EUR, 58.6%, JPY 12.6%, GBP, 11.9%, CAD, 9.1%, SEK, 4.2% and CHF 3.6% weight
The Euro dollar Index (EURX) is a measure of the value of the Euro compared a basket of foreign currencies. It is a weighted mean of the dollar's value compared to
USD, 31.5%, JPY 18.9%, GBP, 30.5%, SEK, 7.9% and CHF 11.2% weight
An example of how I would use the indices to help track trade direction on currency pairs is given below with charts attached. The vertical dotted lines on the chart separate each month. You may need to click on the charts to make them larger for easier viewing.
A look at the daily chart for the GBP/USD for August shows that this pair was pretty choppy with no real clear direction. A look at the USDX chart for this period shows that it was also fairly choppy, not surprising. The USDX had been trading during this time within a symmetrical triangle and, according to triangle theory, was likely to break out, either up or down. From this chart you can then see that the USDX did indeed break out, in an upwards direction, at the beginning of September. The ADX indicator (bottom of chart) supported the direction of the USD trend as being Long (or, moving upwards) from the beginning of September. This observation would then give a trader more confidence with tracking the direction of US currency pairs. So, looking back then to the GBP/USD chart for the start of September you can see that the trend with this pair was down, that is, short for the GBP (and long on the USD). Thus, this trend was supported by observations made from looking at the USDX chart. That is, look to go Long on the USD, relative to other pairs.
In summary, if the USDX is trending up, look for confirmation to trade long on the USD, relative to other pairs. If the USDX is trending down, then look for confirmation to trade short on the USD. The same theory applies to the Euro dollar index, EURX.
I am most grateful to Pierre du Plessis, from FX Mentor Pro, for teaching me about the value of tracking indices in trading FX.