Wednesday, February 18, 2015

Forex trading and Dollar Index

Why is the EUR weighted so heavily? Because it actually consists of over a dozen countries and their own economies, each with their own strengths and weaknesses. Similar to the S&P 500 index, when the Dollar Index is trending up, the strength of the dollar is increasing vs. this basket of currencies, and when trending down, the dollar is weakening vs. this basket of currencies. 

My "problem" with the dollar index and using it to help me trade is the weight of the EUR. Because the EUR is so heavily weighted, the dollar could be weakening against all the other currencies, yet if it is strengthening vs. the EUR, the dollar index could still be going up! This may lead a new trader to doubt what could be a great short trade on the USDCHF. A short trade on the USD/CHF means the dollar is getting weaker while the CHF is getting stronger.

If you choose to use the dollar index as one of your indicators, you need to know and use of this weighting. It can definitely help when trading the EUR/USD pair as the two charts should have an inverse correlation, but when trading the USD/CHF, If you look at the dollar index at all. Here is a chart showing this correlation on weekly charts from last summer:
Look at the dollar index chart is trending lower, the EUR/USD is trending higher, and when the dollar index is trending higher, the EUR/USD is trending lower. Using this correlation on the time frames, your trade can help as an odds enhancer. Notice the difference of the dollar index vs. the USD/CHF. While there is some correlation, it is not nearly as obvious as the EUR/USD pair. Traders need to learn how to watch this for their trading decisions.What happens if you want to trade the GBP, but want to look at the Pound Index? Do this you have to make your own index by looking at several charts. In the following set of charts, we have the GBP/USD, GBP/CAD and the EUR/GBP. In these charts, the trend lines are drawn merely for direction, not as an example of how to draw tradable trend lines! In the first two pairs, the GBP is on the left side of the pair, which is showing GBP weakness on the chart. The third chart has the GBP on the right side, which is showing the GBP getting weaker vs. the EUR. In our imaginary GBP index, what direction would it be going? If you answered down, you would be correct! This will help you make better trades by making up your own index, you should be looking for trades in the directions strength or weakness of the individual currency that your index tells you. By watching the charts if a currency is getting weaker vs. two or three major currencies, it is probably getting weaker vs. all of them. Looking for trades in the general direction of this chart index will help you be right more often an profitable trader.
Their buying and selling actions in the markets they operate in are no different than the actions of the consistently profitable trader. The difference is that the trader can do all this from the comforts of their own home.Dollar Index Trading